What is the difference between Collateralized Mortgage Obligations and other mortgage backed securities?

August 23rd, 2010 | by admin |
Rich P asked:


How do CMO’s differ from any other mortgage-backed bundles? I know fannie mae finances primarily by selling the latter, so what is the benefit in CMO’s in comparison to them?

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    1. No Responses to “What is the difference between Collateralized Mortgage Obligations and other mortgage backed securities?”

    2. By Ranto on Aug 24, 2010 | Reply

      The original MBS were pass-through MBS — where the cash flows (principal plus interest) were passed through to the investors — except for a small piece of the interest that is taken out for servicing. Investors didn’t like the prepayment risks.

      In the mid-1980s, Dexter Senft — then the head of Fixed Income Research at First Boston — came up with the idea for CMOs. With a CMO, the cash flows of the MBS are filtered into several different bonds — each having a different risk profile. These were called Tranches or Classes. Some tranches had very little prepayment risk — while others had a lot. The idea was that by breaking the cash flows into several tranches, it would allow investors to buy pieces that fit their risk profile.

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