Page 78 - FINAL CFA SLIDES DECEMBER 2018 DAY 14

Planned Amortization Class (PAC) Session Unit 15:
CMO, p85 53. Introduction To Asset-Backed Securities

This is structured to make predictable payments, regardless of actual prepayments to the
underlying MBS; it has both reduced contraction risk and reduced extension risk compared to the

underlying MBS.

• Reducing the prepayment risk is achieved by increasing the prepayment risk of the CMO’s
support tranches. If principal repayments are more rapid than expected, the support tranche

receives the principal repayments in excess of those specifically allocated to the PAC tranches.
Conversely, if the actual principal repayments are slower than expected, principal repayments
tanties
to the support tranche are curtailed so the scheduled PAC payments can be made. The larger

the support tranche(s) relative to the PAC tranches, the smaller the probability that the cash
flows to the PAC tranches will differ from their scheduled payments.

• For a given CMO structure there are limits to how fast or slow actual prepayment experience can

be before the support tranches can no longer either provide or absorb prepayments in the
amounts required to keep the PAC payments to their scheduled amounts. The upper and lower

bounds on the actual prepayment rates for which the support tranches are sufficient to either
provide or absorb actual prepayments in order to keep the PAC principal repayments on schedule
are called the initial PAC collar.