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CMO (Collateralized Mortgage Obligation)

A Collateralized Mortgage Obligation (CMO) is a type of mortgage-backed security that pools together various mortgage loans and divides them into different tranches (or classes), each with varying levels of risk and return. The tranches are structured to cater to investors with different risk tolerances, with some tranches offering higher yields but greater risk, while others provide more stability with lower returns. CMOs are designed to distribute the risk of mortgage defaults and prepayments among investors, with payments coming from the underlying mortgage borrowers.

Example

An investor looking for a stable income might invest in the senior tranche of a CMO, which has the least risk of default but offers a lower yield compared to more junior tranches.

Key points

• A CMO is a mortgage-backed security that pools mortgages and divides them into different tranches.

• Each tranche offers varying levels of risk and return to suit different types of investors.

• Payments come from the underlying mortgage borrowers, with risk distributed among tranches.

Quick Answers to Curious Questions

To pool mortgage loans and distribute the payments among different tranches, offering investors varying levels of risk and return.

They are divided into tranches, with each tranche having different levels of risk and return, allowing investors to choose based on their risk tolerance.

Investors face risks such as mortgage defaults, prepayments, and interest rate fluctuations, with higher risk in junior tranches.