Collateralized Mortgage Obligation (CMO) vs. Mortgage-Backed Security (MBS): What’s the Difference?

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Collateralized Mortgage Obligation (CMO) vs. Mortgage-Backed Security (MBS): What’s the Difference?

Collateralized Mortgage Obligation (CMO) vs. Mortgage-Backed Security (MBS):An Overview

Asset-backed securities that employ mortgage-backed securities as collateral include mortgage-backed securities (MBS) and collateralized mortgage obligations (CMO). Investments that are traded on the secondary market are called securities. One kind of MBS is a collateralized mortgage obligation, which is further subdivided into tranches according to risk levels.

Key Takeaways

  • Mortgages are packaged and marketed as a single investment in a kind of MBS known as a collateralized mortgage obligation, or CMO. The mortgages are ranked by maturity and amount of risk.
  • An asset-backed instrument known as a mortgage-backed security, or MBS, is one that reflects the amount of interest in a pool of mortgage loans.

Collateralized Mortgage Obligation

A collateralized mortgage obligation is a more particular kind of mortgage-backed security than the more general phrase “mortgage-backed security,” which broadly refers to asset-backed securities. One sort of MBS that is categorised based on risk and maturity dates is a CMO. With a CMO, mortgages are gathered into a special purpose company, from which various tranches of the securities are then sold to investors.

The Z-tranche or accrual bond is one sort of CMO tranche. Given that it doesn’t get interest or payment until the other CMO tranches have all been settled, this is one of the riskiest CMO tranches.

Some investors choose to invest in CMOs because they want access to mortgage income flows without having to originate or purchase any real mortgages. Among the largest purchasers of CMOs are banks, insurers, mutual funds, and hedge firms.

Without having to purchase or sell a mortgage, interested investors may profit financially from the mortgage sector via collateralized mortgage obligations and mortgage-backed securities.

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Mortgage-Backed Security

The amount of interest in a pool of home loans is represented by an MBS, a kind of asset-backed securities. Consider, for instance, that a mortgage broker that provided money to property owners purchases mortgages from an investment bank. As a result, the investment bank has become a lender to these property owners, and they now pay the bank their mortgage payments.

The investment bank then creates a company or special purpose vehicle to retain the mortgages. The special purpose organization is divided into shares by the investment bank, and these individual shares—known as MBS—start to be sold to investors.

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