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

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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One Response to 'What is the difference between Collateralized Mortgage Obligations and other mortgage backed securities?'

  1. Ranto - March 16th, 2009 at 12:01 am

    Carmel Valley Real Estate

    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.