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A Z bond (also called an
accrual bond) is a type of
bond used in
some CMOs. It is often the last
bond to mature. It pays no interest
while principal is being paid down on earlier bonds. Instead, interest
that would have been paid to the Z bond is instead used to more rapidly pay down principal
on the earlier bonds. Because it accrues interest rather than pay it
out, the Z bond is analogous to a
zero-coupon bond.
Cash flows for a CMO with three
sequential pay bonds
followed by a single Z bond are depicted in Exhibit 1. Note that interest
payments made by mortgagors during the early years of the CMO are treated
as principal payments to the A, B and C bonds. Principal payments made
by mortgagors during the later years of the CMO are treated as payments of
accrued interest to the Z bond.
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A Z bond pays no interest while principal
is being paid down on earlier bonds. |
Z bonds can be incorporated into a variety of CMO
structures. Some CMOs have multiple Z bonds that mature one after
another. Multiple Z bonds do not need to be consecutive. A CMO might have
an intermediate Z bond and a long maturity Z bond with intervening
sequential pay tranches. A CMO might consist entirely of Z bonds.
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 collateralized
mortgage obligation A type of MBS with cash flows segregated
into bonds offering different maturity and risk characteristics.
IO and PO
Risky CMO bonds that pay, respectively, only the interest or only
the principal from a mortgage collateral.
mortgage-backed security
Securitized interest in a pool of mortgages. CMOs are a type of
mortgage-backed security.
PAC bond A type of CMO bond that is
structured to have minimal prepayment risk. Article illustrates an
application of PSA.
prepayment The early retirement of
debt. This article discusses metrics for MBS prepayment, including
SMM, CPR and PSA.
zero-coupon
bond A bond that pays no coupons, pays its par value at
maturity and is issued at a discount. |
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http://www.riskglossary.com
copyright © Glyn A. Holton,
1996
Although the information in
this website has been presented with care and obtained from sources the author believes to be reliable, there is no guarantee that it is
accurate. Such information may be incomplete, condensed, outdated or presented with
errors. The content of the website is for information purposes only. It is
provided gratuitously, so the author shall not be liable under any
theory for any damages suffered by any user. The author does not
provide investment advice, and this website is not a vehicle for communicating
investment advice. |
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