General Securities Representative (Series 7) Practice Exam

What type of CMO tranche is the least likely to be called early?

1. Plain Vanilla CMO

2. Accelerated tranche

3. Z tranche

4. Interest-only tranche

The correct answer is: Z tranche

The Z tranche, also known as the accrual tranche, is least likely to be called early due to its structure. Unlike other tranches, the Z tranche does not receive any principal payments until all other tranches have been paid off. Instead, interest payments are added to the principal, which allows it to accumulate in value. Because it is designed to absorb fluctuations in prepayment risk, the Z tranche provides investors with a longer duration and typically leads to the latest cash flow compared to other tranches. This characteristic makes it less susceptible to early calls, as it is dependent on the complete repayment of more senior tranches. In contrast, other types of tranches, such as the plain vanilla CMO, accelerated tranches, and interest-only tranches, can experience early calls based on changes in interest rates and prepayment patterns. These tranches are often more exposed to investor actions and market conditions that may trigger early payments. Therefore, the Z tranche's definitive structure and cash flow characteristics contribute to its likelihood of avoiding early calls.