Define: Collateralised Mortgage Obligation

A collateralized mortgage obligation (CMO) is a type of mortgage-backed security that is created by pooling together a group of mortgage loans and then issuing multiple classes of securities backed by the cash flows from those loans.

A CMO works by dividing the cash flows from the underlying mortgage loans into different classes or tranches. Each tranche has different characteristics, such as varying interest rates, maturities, and levels of credit risk. Investors can choose to invest in a specific tranche based on their risk appetite and desired return.

The safety of CMOs depends on the specific tranche an investor chooses. Higher-rated tranches typically have lower credit risk and are considered safer investments. However, lower-rated tranches may offer higher yields but come with higher credit risk. It is important for investors to carefully assess the credit quality of the CMO before investing.

CMOs differ from traditional MBS in that they offer multiple classes or tranches with different characteristics, whereas traditional MBS typically have a single class of securities. CMOs provide investors with more flexibility in terms of risk and return profiles.

CMOs are typically issued by government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac, as well as private financial institutions.

Yes, individual investors can purchase CMOs through brokerage firms or financial institutions that offer these securities. However, it is important to understand the risks associated with CMOs and consult with a financial advisor before investing.

Some of the risks associated with investing in CMOs include credit risk (default risk of the underlying mortgage loans), interest rate risk (changes in interest rates affecting the value of the securities), prepayment risk (early repayment of the mortgage loans), and liquidity risk (ability to sell the securities in the market).

Yes, CMOs can be held in retirement accounts such as Individual Retirement Accounts (IRAs) or 401(k) plans. However, it is important to ensure that the investment aligns with the account’s investment objectives and restrictions.

CMOs issued by government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac are regulated by the Federal Housing Finance Agency (FHFA). Additionally, the Securities and Exchange Commission (SEC) regulates the offering and trading of CMOs in the secondary market.