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mortgage-backed bond that separates mortgage pools into different maturity classes, called tranches. This is accomplished by applying income (payments and prepayments of principal and interest) from mortgages in the pool in the order that the CMOs pay out. Tranches pay different rates of interest and can mature in a few months, or as long as 20 years. Issued by the Federal Home Loan Mortgage Corporation (Freddie Mac) and private issuers, CMOs are usually backed by government- guaranteed or other top-grade mortgages and have AAA ratings. In return for a lower yield, CMOs provide investors with increased security about the life of their investment compared to purchasing a whole mortgage-backed security. Even so, if mortgage rates drop sharply, causing a flood of refinancings, prepayment rates will soar and CMO tranches will be repaid before their expected maturity. CMOs are broken into different classes, called companion bonds or planned amortization class (PAC) bonds .
mortgage-backed bond secured by the cash flow of a pool of mortgages. In a CMO, the regular principal and interest payments made by borrowers are separated into different payment streams, creating several bonds that repay invested capital at different rates.
A given pool generally secures several different classes of CMO bonds. ACMO pays the bondholder on a schedule that differs from the mortgage pool as a whole, and includes fast pay, medium pay, and slow pay bonds to suit the needs of different investors. The common arrangements include: a fast-pay bond with a maturity much shorter than the total pool; a bond paying interest only for a period that may be fixed on contingent on how prior CMOs perform, before payment of principal begins; and a bond paying variable interest based on an index, typically the London Interbank Offered Rate (LIBOR) , even though the mortgages themselves may be fixed rate loans.
Fast paying bonds appeal mostly to savings and loans seeking short-term liquidity investments, whereas longer-term CMOs appeal to the investment needs of pension funds and institutional investors. The first CMOs were issued by the Federal Home Loan Mortgage Corp. (Freddie Mac) in 1983. CMOs manage the prepayment risk associated with mortgage-related securities by splitting the pools of mortgage loans into different categories. CMOs pay principal and interest semiannually.
A CMO can be a nonrecourse sale of assets by the issuer, or a liability of the issuer, depending on how a transaction is arranged. The accounting rules in issuing these securities are complex.See also 12b-1 mutual fund , accrual bond , pay-through security , pass-through security , Real Estate Mortgage Investment Conduit (REMIC)
mortgage-backed security that separates mortgage pools into short-medium,and long-term portions.See also ginnie mae pass-through
a security backed by a pool of mortgage loans that may be separated into various classes with varying maturities. Note that REMICs are the standard vehicle for investing in mortgage instruments.
Example: Fidelity Savings and Loan pools $2 million worth of home mortgages to create a collateralized mortgage obligation. Investors in the CMO receive periodic interest and principal payments as well as return of principal as the loans are repaid.
stripped mortgage-backed securities
Copyright c 2006, 2000, 1997, 1993, 1990 by Barron's Educational Series, Inc. Reprinted by arrangement with Publisher.
Copyright © 2007, 2000, 1997, 1987, by Barron's Educational Series, Inc. Reprinted by arrangement with Publisher.
Copyright © 2004, 2000, 1997, 1993, 1987, 1984 by Barron's Educational Series, Inc. Reprinted by arrangement with Publisher.