A planned amortization class (PAC) collateralized mortgage obligation (CMO) is a type of mortgage-backed security that is structured to provide a predictable cash flow to investors.
One of the key features of a PAC CMO is that it is divided into tranches, or layers, with different levels of risk and return. The most senior tranche, known as the PAC tranche, is designed to receive a stable stream of cash flows, even in the event of prepayments or defaults on the underlying mortgages.
The statement that is true regarding PAC CMOs is that the PAC tranche has a priority claim on principal and interest payments, which means that it is the first tranche to receive payments from the underlying mortgages. As a result, investors in the PAC tranche have a high degree of certainty about the timing and amount of their cash flows.
However, this predictability comes at a cost. Because the PAC tranche is insulated from prepayments and defaults, other tranches, such as the support and companion tranches, are exposed to higher levels of risk. In the event that prepayments or defaults exceed a certain level, the PAC tranche will continue to receive its cash flows, while the other tranches may experience losses.
In conclusion, investors in a PAC CMO should be aware of the risks and rewards of investing in this type of security, and carefully consider whether it is a suitable investment for their portfolio.