Collateralized Mortgage Obligations (CMOs)

Collateralized mortgage obligations (CMOs) are a type of mortgage-backed security that is created with the prime motive of redistributing the prepayment risk to different classes of bondholders.

Let’s take a detailed look at how this works. As we learned before, in a pass-through security, the monthly cash flow (scheduled interest, scheduled principal, and unscheduled prepayments) are passed on to all the bond holders on a pro-rata basis. So, all the bond holders are equally exposed to the prepayment risk of the entire pool of mortgage loans.

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