real estate investment strategies citing examples. (25 marks) OUESONEOUB a) Explain contraction risk within the context of mortgage prepayment risk. (5 marks) b) Suppose a portfolio manager is considering a CMO structure. This structure has three tranches. The deal is a simple sequential pay and was issued several years ago. The tranches are A, B and C with a coupon rate paid to each tranche each month and payments are mode to tranche A and then to tranche B. Tranche C is an accrual tranche that accrues coupon interest monthly Tranche Coupon rate (%) Par value Kshs. 3 million Kshs.8 million Kshs.30 million 7 Based on some prepayment rates the projected principal payments (prepayments plus scheduled principal payments) for the next 12 months for the collateral underlying the deal are as follows Month Total Principal payment Month Total principal payment 520,000 510,000 490,000 450,000 448,000 442,000 410,000 405,000 400,000 396,000 395,000 390,000 9 10 12 What is the principal payment, interest and cash flow for tranche A for the first five months? (10 marks) ii iii) What is the principal balance for tranche C for the first five months? (5 marks) (5 marks) What is the average life for tranche A