Modify the Tranche class in Exercise 4.1 to accommodate IO and PO bonds. An interest-only (IO) bond pays interest but not principal. Generally, an IO is linked to one or more other bonds from which it derives its “balance.” The IO pays interest on this effective balance. A principal-only (PO) bond pays no interest, but does pay principal on its balance. A popular combination of these is an “IO/PO split”—an IO linked to a PO. IOs and POs speculate on prepayments. If prepayments are low, then outstanding balances remain high, and interest flows into an IO increasing its value. Thus IO value increases when interest rates increase. If prepayments are high, then principal flows early into a PO increasing its value.
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