Suppose that a PAC bond is created assuming prepayments speeds of 80 PSA and 350 PSA. If the collateral pays at 100 PSA over its life, what will this PAC tranche's average life be?

What will be an ideal response?

As illustrated in Exhibit 12-9, the average life for the PAC bond is stable at 7.26 years as long as the PSA speed is between the two designated prepayments speeds (i.e., between the lower and upper collars). However, at slower or faster PSA speeds than the two collar speeds, the schedule is broken with the average life changing. The average life lengthens when the prepayment speed is less than the lower collar and shortens when it is greater than the upper collar.