What is a CMO. What are the risk characteristics?
CMO stands for Collateralized Mortgage Obligation. Introduced in 1983 as an improvement to the traditional mortgage securities, these are collateralized by pools of residential mortgages. The financial engineers at the issuers (such as Federal Home Loan Mortgage Corporation, Federal National Mortgage Association) divide the CMO into various levels or tranches with different maturities and payment characteristics. The interest and principal payments (including prepayments of principal) are passed through to the holders. Principal payments are made according to a paydown schedule and are generally directed towards one tranche until it is retired and then to the next tranche, and so on sequentially. When interest rates decline, mortgage payers repay and refinance existing debt with the result CMO holders get their principal repaid earlier than originally scheduled . When rates rise, p-repayments are fewer and the CMO takes longer to be repaid. Plain vanilla CMO tranches are those that rec
