CMOS and Other Structured Products
Collateralized Mortgage Obligations (CMOs)
A Collateralized Mortgage Obligation (CMO) is a type of mortgage-backed
security that creates separate classes of securities with varying
maturities and specifications, called tranches. The principal repayments
from the pool of pass-through securities (underlying mortgages) are used
to retire the tranches in accordance with the bond prospectus. The
innovative structure of these securities allows an investor to more
closely tailor yield, maturity or average life expectations to their
specific needs. Agency CMOs carry the guarantee of either Government
National Mortgage Association (GNMA) which conveys the full faith and
credit of the U.S. Government or Federal Home Loan Mortage Corporation
(FHLMC) or Federal National Mortgage Association (FNMA) which are GSEs
(Government Sponsored Enterprises) that were chartered by the Congress
to facilitate the U.S. Mortgage Market.
Amortizing Prepay-Linked Securities (APLS) and Index Amortizing Notes (IANs)
Amortizing Prepayment-Linked Securities (APLS) are unsecured senior
debentures that are issued by various Government Sponsored Entities
(GSEs) such as Federal Home Loan Bank (FHLB), Federal National Mortgage
Association (FNMA) and Federal Farm Credit Bank (FFCB) to fulfill
additional funding needs or to hedge existing mortgage holdings. These
types of securities have also been known as Index Amortization Notes
(IANs) and Prepay-Linked Notes (PPLs). Although classified as agency debt,
these notes combine some of the unique features of a Mortgage-Backed
Security (MBS) such as monthly cash flow of both principal and interest
with a mandatory redemption feature which give the bonds a shorter stated
final maturity thus minimizing extension risk. Each bond is linked to a
reference mortgage-backed security, and the prepayment behavior mirrors the
monthly prepayment speeds on the referenced security.
Other Structured Products
There is a vast array of other structured products available in today’s marketplace including but not limited to:
Range Notes are medium-term notes which are usually
guaranteed by a Government Sponsored Enterprise such as FNMA (Fannie Mae)
FHLMC (Freddie Mac) and FHLB (Federal Home Loan Bank) and carry a rate of
interest that is tied to an index. On the days that the index is at or below
a certain level, the holder of the bond receives interest at the stated
amount. If the index goes above a certain level, the holder of the bond
receives no interest for those days. The rate of interest paid to the owner
of the bond is usually higher than prevailing market rates to make the
security attractive to investors.
Agency (GSE) Guaranteed Step-Ups are typically issued with
maturities ranging from 1 to 20 years with a pre-determined schedule of
coupon rates that gradually increase or “step up” over a period of time.
Most are issued with a call feature of between 3 months and 5 years which
allows the issuer to call the securities back if interest rates should go
lower or if their asset/liability mix should change. The first coupon rate
is usually lower than that of comparable maturity securities, but investors
can achieve a higher yield than can be found on shorter term agency securities.
If the bonds are not called prior to the predetermined step-up schedule, the
investor receives a higher coupon rate than during the initial period.
