CMO's having PAC or TAC tranches will also have
companion or support tranches to absorb the pre-
payment fluctuations that have been removed from
the PAC and TAC tranches.
Once the principal is
paid to the active PAC and TAC tranches according
to the schedule, the remaining excess money or shortfall
is reflected in payments to the active companion
tranche. The average life of a companion tranche
may vary widely, increasing when interest rates rise
and decreasing when rates decline. This timing risk is balanced with higher yields.
Companion tranches offer the potential for higher expected yields when prepayments
remain close to the rate assumed at purchase.
Similar to Type II and Type III PACs, TAC tranches
can serve as companion tranches for PAC tranches.
These lower-priority PAC and TAC tranches will in
turn have companion tranches further down in the
principal payment priority.
Companion tranches are
often offered for sale to individual bond investors who want
higher income and are willing to assume more risk of
having their principal returned sooner or later than
expected.
These are less exact CMO Tranches
CMO Bonds - More from American Investment Training's Investing Glossary.
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