Definition of collateralised mortgage obligation CMO

Mortgage-backed bond divided into different classes or tranches of maturity, each paying a different interest rate. Interest payments to CMO holders and redemption of each tranche are directly related to the principal and interest received from the holders of the underlying mortgages and passed into a pool. As money is taken from the pool, each tranche of the CMO is successively redeemed. Popular in the US, CMOs are normally backed by top grade mortgages and are seen as relatively secure investments. A collateralised bond obligation (CBO) is similar in concept, except that the security is made up of bonds of varying credit quality. Each tranche, in this case called a tier, is backed by a different kind of bond - the higher the quality of the collateral, the lower the interest rate, and vice-versa. Typically, the bottom tier is backed by high-risk junk bonds and pays whatever is left in the pool after interest on the higher-quality tiers is paid. See covered bond; mortgage-backed securities.

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