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Alex Lapin, CFA, works for a professional review organization. His job is to deliver lectures to help CFA candidates to best prepare for passing the CFA exam. Today, Alex intends to cover collateralized mortgage obligations (CMOs). Alex has prepared three sample CMO structures, with each representing a key type of CMO.

Two of the student's in Lapin's class are discussing CMOs before class. Both students agree that the motivation of creating CMO structures is to reallocate default risk and prepayment risk among different bond classes, called tranches, within a CMO structure. However, Student 1 argues that all forms of CMO structures reallocate both default risk and prepayment risk, while Student 2 claims that some CMO structures do not directly reallocate default risk among tranches.

During class, Lapin asks his class to select the tranche from the sequentialpay tranche CMO (Table shown above) that has the least extension risk from the sequentialpay tranche CMO, and he asks them to select the tranche from the PAC/support tranche CMO (Table 5 above) that has the highest contraction risk.

After class, one student asks Lapin to confirm how to measure prepayment rates. The student states his understanding that prepayment rates can be measured using the single monthly mortality (SMM) and the conditional prepayment rate (CPR). He also makes the following two statements concerning the SMM and CPR:

• Statement 1: The CPR and SMM are two totally unrelated measures of prepayment rates, and most market participants rely on the SMM.
• Statement 2: A 3% CPR means that approximately 3% of the beginning of the year mortgage balance is expected to be prepaid by year's end.

In discussing measures of prepayment rates, the student is most likely correct in making:

Group of answer choices

Statement 2, only.

neither statement.

Statement 1, only.

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