Business Glossary

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.

synonym for error. It is calculated by subtracting the forecast value from the actual value to give a "residual" or error value for each forecast period.

bonds or notes backed by loan paper or accounts receivable originated by banks, credit card companies, or other providers of credit and often "enhanced" by a bank Letter of Credit or by insurance coverage provided by an institution other than the issuer. Typically, the originator of the loan or accounts receivable paper sells it to a specially created trust, which repackages it as securities with a minimum denomination of $1,000 and a term of five years or less. The securities are then underwritten by brokerage firms who reoffer them to the public. Examples are Certificate for Automobile Receivables (CARs) and so-called plastic bonds, backed by credit card receivables. Because the institution that originated the underlying loans or receivables is neither the obligor nor the guarantor, investors should evaluate the quality of the original paper, the worth of the guarantor or insurer, and the extent of the protection.

1. securities rated as sub-investment paper by an investment advisory service, and thus an unsuitable investment for a bank investment portfolio or trust department. Speculative securities are rated by Standard & Poor's as grade BB or lower, and by Moody's Investors Service as Ba or lower. See also junk bond.
2. investment security subject to loss of interest or principal, or both. Banking regulators have discouraged investing in certain types of derivative mortgage-backed securities, unless these are used as a hedging device to limit interest rate risk. These include stripped mortgage-backed securities-such as interest-only (io) stripand principal-only (PO) strip-and also trading inwhen issued securities, that is, buying a security in the interim between the announcement date and the offering date, in the hope of making a quick profit.