Series 6: 4.2.12.2. Collateralized Mortgage Obligations (CMOs)

4.2.12.2. Collateralized Mortgage Obligations (CMOs)

Collateralized mortgage obligations (CMOs) are another type of asset-backed security. CMOs are pass-through securities that are issued by a GSE or a private sector financing corporation and are often backed by Fannie Mae, Freddie Mac, and Ginnie Mae. They often are rated AAA.

Unlike a traditional MBS that has one coupon rate and maturity date, a CMO offers a range of coupon rates and maturity dates for investors to choose from. The monthly payments from the CMO will be a combination of varying amounts of both interest and principal. Therefore, the CMO investor’s principal is returned over the life of the security, rather than repaid in a single lump sum at maturity as with other types of debt securities. As the principal is repaid or prepaid by the mortgage holders, interest payments become smaller because they are based on a lower amount of outstanding principal.

The CMO’s pool of investments is sliced up into tranches (slices, in French). The bonds in the various tranches offer different rates of interest, repayment