The Bulldawg Mortgage Company is issuing a CMO with three tranches. The A tranche will consist of $40.5 million principal with a coupon of 8.25 percent. The B tranche will be issued with a coupon of 9.0 percent and a principal of $22.5 million. The Z tranche will carry a coupon of 11.0 percent with a principal of $45 million. The mortgages backing the security issue were originated at a fixed rate of 10.5% with a maturity and amortization of 10 years (annual payments). The issue will be overcollateralized by $4.5 million[1], and the issuer (Bulldawg) will receive all net cash flows after priority payments are made to each class of securities.[2] Tranche A, B and Z will receive their coupon interest each year.Principal from the mortgage payments will go first to pay down the principal balance of the A tranche.Once the A bond is entirely paid off, the mortgage principal payments will pay down the balance of the B bond.Once the B bond is entirely paid off, mortgage principal payments will bay down the balance of the Z bond. Mortgage defaults losses will be absorbed by the "residual" cash flows, then the Z tranche, then the B tranche, then the A tranche.

1)Why do you think the A tranche has a coupon rate well below the contract rate on the mortgages?

2)What will the maturity (in years) of each tranche be assuming no prepayment of the mortgages in the pool?

TrancheMaturity

Tranche A:

Tranche B:

Tranche Z: