Series 7 practice questionhardCMOs — Scenario — Investor Suitability
A conservative investor seeking predictable monthly income for the next 5 years should consider which CMO tranche?
- ACompanion tranche for its higher yield
- BZ-tranche for its high accrued interest
- CPAC tranche with an expected average life matching the 5-year horizon✓ Correct answer
- DInterest-only (IO) strip
Explanation
Why C — PAC tranche with an expected average life matching the 5-year horizon
A PAC (Planned Amortization Class) tranche with an expected average life of approximately 5 years would be most suitable for a conservative investor seeking predictable income. PAC tranches have the most predictable cash flows because companion tranches absorb prepayment variability. Z-tranches pay no current income, companion tranches have highly volatile cash flows, and IO strips decrease in value when prepayments increase.
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