Business Glossary

security backed by mortgages. Such certificates are issued by the Federal Home Loan Mortgage Corporation, and the Federal National Mortgage Association. Others are guaranteed by the government national mortgage association. Investors receive payments out of the interest and principal on the underlying mortgages. Sometimes banks issue certificates backed by conventional mortgage, selling them to large institutional investors. The growth of mortgage-backed certificates and the secondary mortgage market in which they are traded has helped keep mortgage money available for home financing.

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.

security backed by mortgages. Such certificates are issued by the Federal Home Loan Mortgage Corporation, and the Federal National Mortgage Association. Others are guaranteed by the government national mortgage association. Investors receive payments out of the interest and principal on the underlying mortgages. Sometimes banks issue certificates backed by conventional mortgage, selling them to large institutional investors. The growth of mortgage-backed certificates and the secondary mortgage market in which they are traded has helped keep mortgage money available for home financing.