Targeted Amortization Class (TAC): Definition, Structure, and Practical Application
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Summary:
Targeted amortization class (TAC) is an asset-backed security aimed at mitigating prepayment risk by adhering to a specific principal payment schedule based on a single prepayment speed assumption (PSA). This article explores TAC in-depth, including its structure, relationship with planned amortization class (PAC), and its role in collateralized mortgage obligations (CMO) and mortgage-backed securities (MBS).
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What is targeted amortization class (TAC)?
Targeted amortization class (TAC) is a specialized type of asset-backed security designed to protect investors from prepayment risk. TAC tranches adhere to a predetermined principal balance schedule established using a single prepayment speed assumption (PSA). Unlike planned amortization class (PAC) tranches, which incorporate a range of prepayment rates, TAC tranches rely solely on one PSA.
Understanding targeted amortization class (TAC)
TAC tranches enhance cash flow predictability within asset-backed securities, particularly collateralized mortgage obligations (CMO) and mortgage-backed securities (MBS). As a form of bond within these structures, TAC tranches follow a predetermined principal payment schedule. Any prepayments are amortized to maintain this schedule, ensuring consistent cash flow even amidst changing prepayment rates and interest rate environments.
The relationship between TAC and PAC
While PAC tranches incorporate a range of prepayment rates into their structure, TAC tranches rely on a single prepayment speed assumption. Consequently, TAC investors may receive more or less principal than scheduled based on actual prepayment rates. In scenarios where prepayment rates fall below the defined rate, TAC tranches may require an extension to fulfill scheduled payments. Conversely, if prepayment rates exceed the PSA used for TAC, investors may face returns in a less favorable interest rate environment.
Frequently asked questions
How do targeted amortization class (TAC) tranches protect investors?
TAC tranches protect investors from prepayment risk by adhering to a specific principal payment schedule based on a single prepayment speed assumption (PSA). This structure ensures a predictable cash flow even amidst changing prepayment rates.
What assets are typically associated with TAC tranches?
TAC tranches are commonly linked with collateralized mortgage obligations (CMO) and mortgage-backed securities (MBS), where they serve as a bond-like component.
How do TAC tranches differ from PAC tranches?
Unlike PAC tranches, which utilize a range of prepayment rates, TAC tranches rely on a single prepayment speed assumption. This difference affects the predictability of principal payments based on actual prepayment rates.
What impact does the existence of PAC tranches have on TAC tranches?
PAC tranches are senior to TAC tranches, yielding lower but safer returns. This hierarchical structure affects the risk and return profiles of TAC tranches within asset-backed securities.
Key takeaways
- TAC tranches provide investors with a predictable cash flow and fixed principal payment schedule.
- Unlike PAC tranches, TAC tranches rely on a single prepayment speed assumption, impacting their responsiveness to actual prepayment rates.
- TAC tranches are commonly associated with collateralized mortgage obligations (CMO) and mortgage-backed securities (MBS).
- The existence of PAC tranches influences the risk and return profiles of TAC tranches within asset-backed securities.
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