A tranche of a collateralized mortgage obligation (CMO) that converts a long-term mortgage product with irregular and unstable cash flows into short, medium, and long-term collateralized bonds. It exhibits considerable cash flow stability (in terms of price and return) by shifting prepayment risk to a companion bond which protects the structure from accelerating prepayments. In other words, the cash flow of a planned amortization class bond (PAC bond) will therefore be known for certain as long as its support bonds are not entirely paid off. As such, investors can enjoy a constant yield for a band of prepayment speeds.
As opposed to other CMO tranches, the PAC bond has a sinking fund that remains in effect as long as prepayments stay within the specified prepayment speed bands. The PAC band guarantees that if prepayments are made at single constant speed within the band and remain there, the PAC payment schedule will be met.
This bond is also known as a simultaneous-pay bond.
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