Features and Characteristics of CMOs. Collateralized Mortgage Obligation - Risk Encyclopedia. The Various Types of CMOs. The most basic CMO structure has tranches that pay in a strict sequence.
Each tranche receives regular interest payments, but the principal payments received are made to the first tranche alone, until it is completely retired. Once the first tranche is retired, principal payments are applied to the second tranche until it is fully retired, and the process continues until the last tranche is retired.
The first tranche of the offering may have an average life of 2-3 years, the second tranche 5-7 years, the third tranche 10-12 years, and so forth. This type of CMO is known as a “sequential pay,” “clean,” or “plain vanilla” offering. The CMO structure allows the issuer to meet different maturity requirements and to distribute the impact of prepayment variability among tranches in a deliberate and sometimes uneven manner. Planned Amortization Class (PAC) Tranches. “Type I PAC” tranches maintain their schedules over the widest range of actual prepayment speeds—say, from 100% to 300% PSA.
Collateralized Mortgage Obligation (CMO) Definition. DEFINITION of 'Collateralized Mortgage Obligation - CMO' A type of mortgage-backed security in which principal repayments are organized according to their maturities and into different classes based on risk.
A collateralized mortgage obligation is a special purpose entity that receives the mortgage repayments and owns the mortgages it receives cash flows from (called a pool). The mortgages serve as collateral, and are organized into classes based on their risk profile. Income received from the mortgages is passed to investors based on a predetermined set of rules, and investors receive money based on the specific slice of mortgages invested in (called a tranche). INVESTOPEDIA EXPLAINS 'Collateralized Mortgage Obligation - CMO' Collateralized mortgage obligations are complex financial instruments. Investors in CMOs look to obtain access to mortgage cash flows without having to originate or purchase a set of mortgages themselves.
Collaterized Mortgage Obligations (CMOs) Collateralized mortgage obligations (CMOs), a type of mortgage-backed security, are bonds that represent claims to specific cash flows from large pools of home mortgages.
The streams of principal and interest payments on the mortgages are distributed to the different classes of CMO interests, known as tranches, according to a complicated deal structure. Each tranche may have different principal balances, coupon rates, prepayment risks, and maturity dates (ranging from a few months to twenty years). CMOs are often highly sensitive to changes in interest rates and any resulting change in the rate at which homeowners sell their properties, refinance, or otherwise pre-pay their loans. Investors in these securities may not only be subjected to this prepayment risk, but also exposed to significant market and liquidity risks. You can learn more about CMOs by visiting the website of the Securities Industry and Financial Markets Association.
Collateralized mortgage obligation. A collateralized mortgage obligation (CMO) is a type of complex debt security that repackages and directs the payments of principal and interest from a collateral pool to different types and maturities of securities, thereby meeting investor needs.[1] CMOs were first created in 1983 by the investment banks Salomon Brothers and First Boston for the U.S. mortgage liquidity provider Freddie Mac.
(The Salomon Brothers team was led by Gordon Taylor. The First Boston team was led by Dexter Senft[2]). Investors in CMOs include banks, hedge funds, insurance companies, pension funds, mutual funds, government agencies, and most recently central banks. This article focuses primarily on CMO bonds as traded in the United States of America. Purpose[edit] The most basic way a mortgage loan can be transformed into a bond suitable for purchase by an investor would simply be to "split it".
Salomon Brothers and First Boston created the CMO concept to address these issues. Credit protection[edit]