Collateralized Mortgage Obligation

<body onLoad="MM_checkPlugin('Shockwave Flash','','http://www.riskglossary.com/default_nofl.htm',false);return document.MM_returnValue" stylesrc="../_private/template.htm" bgcolor="#FFFFFF" link="#669933" vlink="#000000" alink="#000000"> <div align="left"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table1"> <tr> <td width="740"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" height="37" id="table2"> <tr> <td height="35" width="100%"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" id="table3"> <tr> <td width="100%" align="left" valign="top"> <p class="header_gold">Collateralized Mortgage Obligation</td> <td width="45" align="right" valign="bottom"> <map name="FPMap6"> <area href="http://www.contingencyanalysis.com" shape="rect" coords="1, 0, 44, 11" target="_top"> </map> <img border="0" src="../images/home.gif" usemap="#FPMap6" width="45" height="12"></td> </tr> </table> </td> </tr> <tr> <td width="100%" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td width="0%" valign="top" bgcolor="#FFFFCC"> <table border="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" cellspacing="1" id="table4"> <tr> <td width="0%" align="left" valign="top"> <p class="header2_black">Explained:<br> <img border="0" src="../images/blank_1x100.gif" width="100" height="1"></td> <td width="100%" align="left" valign="top"><p class="word_list"> <a href="#collateralized mortgage obligation">collateralized mortgage obligation</a><p class="word_list"> <a href="#sequential structure">sequential pay CMO bond</a><br> <img border="0" src="../images/blank_1x160.gif" width="160" height="1"></td> </tr> </table> </td> </tr> </table> <table border="0" cellpadding="0" style="border-collapse: collapse" bordercolor="#111111" width="310" align="right" id="table5"> <tr> <td align="right" width="9" height="14"></td> <td width="300" height="14"> <font size="2"> </font><font size="4"> </font></td> </tr> <tr> <td align="right" width="9"> </td> <td width="300"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> </tr> </table> <p class="body">A <b><a name="collateralized mortgage obligation"> collateralized mortgage obligation</a></b> (CMO) is a type of <a href="../articles/mortgage_backed_security.htm">mortgage-backed security</a> (MBS). Unlike a <a href="../articles/mortgage_backed_security.htm">mortgage pass-through</a>, in which all investors participate proportionately in the net cash flows from the mortgage <a href="../articles/collateral.htm">collateral</a>, with a CMO, different <a href="../articles/coupon_bond.htm">bond</a> classes are issued, which participate in different components, called <a href="../articles/securitization.htm">tranches</a>, of the net cash flows. A CMO is any one of those bonds. The tranches are structured to each have their own <a href="../articles/risk.htm">risk</a> characteristics and maturity range. In this way, investors can select a bond offering the characteristics which most closely meet their needs. Collateral for the securitization may represent a pool of mortgages, but it is often a mortgage pass-through.</p> <p class="body">Many arrangements are possible. One of the simplest is a <b><a name="sequential structure">sequential pay</a></b> structure comprising three or four tranches that mature sequentially. All tranches participate in interest payments from the mortgage collateral, but initially, only the first tranch receives <a href="../articles/par_value.htm">principal</a> payments. It receives all principal payments until it is retired. Next, all principal payments are paid to the second tranch until it is retired, and so on. This process is illustrated for a three-tranch sequential pay structure in Exhibit 1: </p> <div align="center"> <center> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="350" cellpadding="0" id="table6"> <tr> <td> <p class="exhibit_header"><span class="exhibit_header">Example: Three Sequential Pay Bonds</span><br> <span class="exhibit_subheader">Exhibit 1</span></td> </tr> <tr> <td bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td> <img border="0" src="../images/ex1_collateralized_mortgage_obligation.gif" width="350" height="160"></td> </tr> <tr> <td> <p class="exhibit_legend">The segregation of cash flows into three sequential pay tranches is illustrated. All three participate in interest payments, but principal payments flow exclusively to the A bonds until they are retired. After that, all principal payments flow to the B bonds until they are retired. Finally, all principal payments flow to the C bonds until they are retired.</td> </tr> </table> </center> </div> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="345" align="left" id="table7"> <tr> <td width="336" height="10"><font size="2"> </font></td> <td width="9" height="10"></td> </tr> <tr> <td width="336"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> <td width="9"> </td> </tr> </table> <p class="body">CMOs entail the same <a href="../articles/mortgage_backed_security.htm">prepayment risk</a> as mortgage pass-throughs. The riskiness of a specific bond depends upon how that tranch is structured and on the underlying collateral. Many different structures are used in practice, including stable <a href="../articles/pac_bond.htm">PAC bonds</a> or risky <a href="../articles/io_and_po.htm">IOs and POs</a>. There are <a href="../articles/floater.htm">floaters</a> and <a href="../articles/inverse_floater.htm"> inverse floaters</a>. There are also <a href="../articles/z_bond.htm">Z-bonds</a>, which are analogous to <a href="../articles/zero_coupon_bond.htm">zero-coupon bonds</a>.</p> <p class="body">Like mortgage pass-throughs, CMOs typically have minimal <a href="../articles/credit_risk.htm">credit risk</a>. Either they have a high quality mortgage pass-through or similar MBS as collateral, or the collateral is bundled with suitable <a href="../articles/credit_enhancement.htm">credit enhancement</a>.</p> <p class="body">CMOs are issued by various organizations, including <a href="../articles/mortgage_backed_security.htm">Fannie Mae</a>, <a href="../articles/mortgage_backed_security.htm">Freddie Mac</a>, investment banks, mortgage originators, insurance companies, etc.</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table8"> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Related Internal Links</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" colspan="2"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" id="table9"> <tr> <td width="100%"> <p align="left" class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/floater.htm">floater</a> A fixed income instrument whose coupon fluctuates with some designated reference rate.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/inverse_floater.htm">inverse floater</a> A floater whose coupon varies inversely to its reference rate.</p> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/io_and_po.htm">IO and PO</a> Risky CMO bonds that pay, respectively, only the interest or only the principal from a mortgage collateral.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/mortgage_backed_security.htm">mortgage-backed security</a> Securitized interest in a pool of mortgages. CMOs are a type of mortgage-backed security.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/pac_bond.htm">PAC Bond</a> A type of CMO bond that is structured to have minimal prepayment risk. Article illustrates an application of PSA.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/prepayment.htm">prepayment</a> The early retirement of debt. This article discusses metrics for MBS prepayment, including SMM, CPR and PSA.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/securitization.htm">securitization</a> The process of pooling assets and selling interests in the pool to investors.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/z_bond.htm">Z bond</a> A type of CMO bond that accrues interest until it starts to pay down principal.</td> </tr> </table> </td> </tr> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Sponsored Links</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" width="75"> <img border="0" src="../images/ad_side_banner_2.jpg" width="103" height="285"></td> <td bgcolor="#FFFFCC" width="99%">  <p class="ad_legend" style="margin-left: 0; margin-bottom:2"> <a target="_top" href="http://www.riskexpertise.com/link/advertising.htm"> <font color="#000000">Ads by Contingency Analysis</font></a></p> <p style="margin-top: 0; margin-bottom: 0"> <iframe src="http://servedbyadbutler.com/adserve/;ID=147917;size=336x265;setID=82436;type=iframe" style="margin: 0px; padding: 0px; border-width: 0px" width="336" height="265" frameborder="0" marginwidth="0" marginheight="0" scrolling="no" name="I1"> <![if lt IE 4]> <script src="http://servedbyadbutler.com/adserve/;ID=147917;size=336x265;setID=82436;type=js" type="text/javascript"> </script> <noscript> <a href="http://servedbyadbutler.com/go2/;ID=147917;size=336x265;setID=82436"> <img src="http://servedbyadbutler.com/adserve.ibs/;ID=147917;size=336x265;setID=82436;type=img" border="0" height="265" width="336" alt=""></a> </noscript><![endif]></iframe>   </td> </tr> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Related Books</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" colspan="2"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" id="table10"> <tr> <td width="100%"> <p class="explanatory_text">Fabozzi (<a target="_blank" href="http://www.riskbook.com/link/fabozzi_f_(2001).htm">2001</a>) and Hayre (<a target="_blank" href="http://www.riskbook.com/link/hayre_l_(2001).htm">2001</a>) are two excellent, comprehensive books on MBS. 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