DEFINITION of 'Companion Bond'
A class of tranche found in a planned amortization class (PAC) bond that is responsible for protecting the PAC tranche from both contraction and extension risk. The companion bond is designed to absorb excess principal payments during times of high prepayment speeds and defer receiving principal payments during times of low prepayment speeds.
Also known as a "support tranche" or "companion tranche"
BREAKING DOWN 'Companion Bond'
More specifically, in situations of high prepayment speeds, the companion bond takes as much of the excess prepayments from the PAC tranche as possible and uses them to repay its own principal amount. Once its portion of the principal is completely paid off, all excess principle payments go back to the PAC bond.
Conversely, in situations of low prepayment speeds, the companion bond defers the reception of any payments. The principal payments then go toward paying off the PAC bond.
As long as the prepayment speed stays within the designated upper and lower PAC collars, the companion bond will be able to operate as designed.