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Answer: If we increase the PSA prepayment assumption (e.g., 100% PSA to 200% PSA), the duration of each Tranche in a CMO will increase
**Correct answer: D** - **A is true**: A CMO differs from a pass-through MBS because it **redistributes the mortgage cash flows into tranches** with different timing and risk characteristics. - **B is true**: For the same mortgage collateral, the **aggregate value** of the tranches should equal the MBS value, and the **weighted-average duration** of the tranches should be consistent with the pool’s duration. - **C is true**: In a sequential structure, the last tranche to receive principal has the **longest average life** and therefore the **highest duration / greatest interest rate risk**. - **D is false**: Increasing the PSA assumption means **faster prepayments**, which generally **reduces** tranche durations, not increases them. So the exception is **D**.
Author: Manit Arora
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Q-106.1. Each of the following is true about collateralized mortgage obligations (CMOs) EXCEPT:
A
The primary difference between a CMO and an pass-through MBS is that a CMO structures the cash flows into tranches with various risk/return profiles
B
For a given mortgage pool, the value and duration of the MBS should equal, respectively, the sum of the tranche values and weighted average duration of the CMO
C
In a sequential CMO with four tranches, if Tranche D receives principal only after the other three Tranches are fully repaid, Tranche D offers greater interest rate risk (i.e., has the highest duration)
D
If we increase the PSA prepayment assumption (e.g., 100% PSA to 200% PSA), the duration of each Tranche in a CMO will increase
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