3.28.2005

Q: Given the prepayment risk of...

...a MBS such as GNMA and that of a Z tranche in a CMO, which investors will prefer the Z tranche, which GNMA?

A: GNMAs simply pass through the prepayments on a pro-rata basis to the investors. On the other hand, the Z tranche is protected from prepayments for a much longer period because all of the previous tranches have to be prepaid before any prepayments are applied to the Z tranche.

The Z tranche of a CMO will typically have a longer duration than the GNMA and thus should be more attractive to pension funds and insurance companies. GNMAs will be more attractive to investors who have liabilities that are callable because they provide a better asset-liability match.

Category: C++ Quant > Debt

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