I would like to inquire about a specific type of Z-Tranches used in CMOs

As part of the different collateral mortgage obligation (CMO) structures, we see a specific type of tranches named "Z-Tranche". It is specifically designed to act as a cushion to be able to secure the promised amortization on the other more senior tranches that shares the same pool of loans. To fulfill that purpose, on each payment date, I understand that the Z-Tranche can:

  • Either re-invest the interest coupon into the notional, and therefore no payment (interest or capital) is passed to the investor of this tranche. In that case, the published pool factor would be greater than that of the previous month
  • Or amortize as a normal MBS does, by paying interest and capital based on the published pool factor that is lower than that of the previous month

Though normally a Z-Tranche starts by acrreting for a series of date and thereafter at a given moment starts amortizing back, there is no rule for that e.g. this tranche can acrrete on the first period, amortize on the second one and then again accrete on the third one

First, is my above understanding correct? Second, can this tranche have a partial accretion of coupon to the notional? (i.e. pay a small part and re-invest the rest into the notional)



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