Series 7 practice questionhardCMOs — Z-Tranche
A Z-tranche (accrual tranche) in a CMO is characterized by:
- AReceiving the first principal payments in the structure
- BBeing guaranteed by the US government against default
- CHaving a floating interest rate that adjusts monthly
- DReceiving no interest or principal payments until all other tranches are retired, with interest accruing and added to the principal balance✓ Correct answer
Explanation
Why D — Receiving no interest or principal payments until all other tranches are retired, with interest accruing and added to the principal balance
The Z-tranche (also called the accrual tranche) receives no cash payments until all prior tranches have been retired. During this period, interest accrues and is added to the Z-tranche's principal balance (similar to a zero-coupon bond). Once all other tranches are paid off, the Z-tranche begins receiving both principal and the accumulated accrued interest. Z-tranches have the longest average life and greatest interest rate sensitivity.
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