1. Assume there are a bunch of mortgages that are supposed to pay principal paym

Question

1.     Assume there are a bunch of mortgages that are supposed to pay principal payments and interest payments of $2100 during the year are pooled together and sold as securities. These securities have tranches which include I, II, III, and IV. Tranche I is supposed to collect $1000 in principal, tranche II is supposed to collect $500 in principal, tranche III is supposed to collect $300 in principal, and Tranche IV is supposed to collect $200 in principal. Tranche IV has the highest yield assuming that all principal is paid. The annual total interest cost is $100, and this is paid before principal is paid to any of the tranches.

Assume that homeowners default on their mortgages and they only pay $1200 during the year. How much does tranche II collect in principal?

a)     $0

b)     $100

c)     $200

d)     $300

e)     $400

f)     $1200

g)     $1400

h)    $2100

Explanation / Answer

$100 out of the $1200 is actually interest.

So principal payment made = 1200-100 = 1100

Out of this $1100 principal payment made, 1000 is made to Tranche I

So principal to Tranche II = 1100-1000 = $100

So the answer is choice B

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