mortgage security consisting of the principal portion of stripped mortgage-backed securities. PO strips are created by separating the principal payments from the interest payments collected from a pool of mortgage pass-through securities. The principal payments are combined, regardless of whether principal is paid early or at final maturity.
PO strips are priced and traded at a discount from par value, like zero-coupon issues, rising to par at maturity. PO strips can have high yields if prepayments are accelerated (and interest rates decline), but can have returns much lower than expected if interest rates begin rising. At worst, the return to the investor may never reach the purchase price, resulting in a loss. POs are used mostly to hedge interest rate movements, for example, as a protection against prepayment risk, or the risk of portfolio losses from a sudden increase in mortgage prepayments by mortgagors.
