hard · Asset-Backed Securities
An investor buys a 'Z-bond' (accrual bond) in a CMO structure at a discount.
If the preceding tranches experience extension risk, what is the impact on the Z-bond?
- The Z-bond's price increases because its cash flows are now more certain.
- The Z-bond is unaffected because it does not receive principal until the very end of the transaction.
- The Z-bond's realized yield increases because it accrues more interest at the high coupon rate during the extension.
- The Z-bond's WAL extends, and its realized yield falls because the realization of the purchase discount is delayed.
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