The Pretty Lake Bank Corp. has placed $100 million of GNMA-guaranteed securities in a trust account off

Question:

The Pretty Lake Bank Corp. has placed $100 million of GNMA-guaranteed securities in a trust account off the balance sheet. A CMO with four tranches has just been issued by Pretty Lake using the GNMAs as collateral. Each tranche has a of $25 million and makes monthly payments. The annual rates are 4.5 percent for Tranche A, 5 percent for Tranche B, 5.5 percent for Tranche C, and 6.5 percent for Tranche D.
a. Which tranche has the shortest maturity, and which tranche has the most prepayment protection?
b. Every month principal and interest are paid on the outstanding mortgages, and some mortgages are paid in full. These payments are passed through to Pretty Lake, and the trustee uses the funds to pay coupons to CMO bondholders. What are the payments owed for each tranche for the first month?
c. If scheduled mortgage payments and early prepayments bring in $5 million, how much will be used to retire the principal of CMO bondholders and which tranche will be affected?
d. Why does Tranche D have a higher expected return?

Coupon
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a... Face Value
Face value is a financial term used to describe the nominal or dollar value of a security, as stated by its issuer. For stocks, the face value is the original cost of the stock, as listed on the certificate. For bonds, it is the amount paid to the...