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Answer: The life of the Companion bond will be greater than the life of the PAC bond, regardless of whether PSA is 80% or 300%
### Correct answer: **C. The life of the Companion bond will be greater than the life of the PAC bond, regardless of whether PSA is 80% or 300%** A PAC structure is designed so that, **as long as prepayments stay within the PAC band**, the PAC bond receives a more stable and predictable principal schedule. - **A is true**: the **Companion/support bond** absorbs the variability in prepayments. - **B is true**: the PAC bond has a **predictable cash flow profile and average life** within the band. - **D is true**: the Companion bond bears the prepayment uncertainty, so it has **greater negative convexity** than the PAC bond. - **C is the exception**: the Companion bond does **not necessarily** have a longer life than the PAC bond at every point within the band. Its life can shorten materially when prepayments are high (near 300% PSA). The key point is that the Companion is the residual piece, not that it is always longer-lived. Therefore, **C** is the statement that is not always true.
Author: Manit Arora
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Question 107.2. A CMO planned amortization class (PAC) has only two bonds: The PAC band (Tranche A) and the Companion (aka, support) bond. The PAC bank is structured with a band range of 80% PSA to 300% PSA. If we ASSUME that the PSA level remains within the 80% to 300% range, each of the following is true EXCEPT:
A
The Companion band absorbs all prepayment risk and the PAC band absorb none
B
The cash flow profile and life of the PAC band is predictable
C
The life of the Companion bond will be greater than the life of the PAC bond, regardless of whether PSA is 80% or 300%
D
The Companion bond will have stronger (more) negative convexity than the PAC band
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