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Collateralized Mortgage Obligations or CMO's are a series of bonds backed by an agency and their mortgage backed securities. These investments are AAA rated and pay monthly principal and interest.
Collateralized Mortgage Obligations differ from pass through securities in that they have different types of paying bonds within the CMO.
A CMO has different payment timing risk depending on the type of bond you own. Some offer more protection than others from prepayment or extension risk. These bonds have a more predicatable duration to the bondholder vs. a pass through agency bond. Some CMO's can pay off faster than others.
Collateralized Mortgage Obligations are generally meant for institutional investors or wealthy bond investors. The money invested, while earning monthly income - can take a while if interest rates rise. When interest rates rise, a these bonds will pay slower. The refinancing that normally can happen with mortgage pools will slow down or stop when interest rates or bond yields rise.
Types
Plain Vanilla
This is a cmo bond that is set up more simply than others - thus the name "plain vanilla". It spreads the principal and interest payments to all tranches. The principal is apllied to the early tranches first and paying them off the earliest. Plain vanilla Collateralized Mortgage Obligations have prepayment and extension risk.
PAC - Planned Ammortization Class
A PAC Bond or Planned Ammortization Class CMO has more predicatble cash flows and more certainty of final maturity for the investor. A PAC bond has certain protections against pre payment risk or extension risk.
Copyright  2006 American Investment Training, Inc.
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