Collateralized Mortgage Obligations
Stripped MBS, and ABS
1. Collateralized Mortgage Obligations
2. Stripped Mortgage-backed Securities
3. Brief introduction of ABS and collateralized
debt obligations
Fin431x (Ch 12, 13, 14, 15)
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CMOs
Bond classes created by redirecting the cash flows of
mortgage-related products so as to mitigate
prepayment risk.
Pay-through structure: there are more than one class
of bondholders with the same level of credit priority
Tranches: different bond classes
Fin431x (Ch 12, 13, 14, 15)
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Materials Covered under CMOs
Sequential-Pay Tranches (basic)
Accrual Tranche
Floater and Inverse Floater
Planned Amortization Class versus Support
Class
Fin431x (Ch 12, 13, 14, 15)
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Sequential-Pay Tranches
The collateral for the hypothetical CMO is a hypothetical
pass-through with total par value of $400 million and the
following characteristics :
(1) The pass-through coupon rate is 7.5%
(2) WAC=8.125%
(3) WAM=357 month
(4) 165PSA
(page 275):
Fin431x (Ch 12, 13, 14, 15)
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FJF-01
Tranche
A
B
C
D
1.
2.
Par Amount
194,500,000
36,500,000
96,500,000
73,000,000
?
Coupon Rate(%)
7.5
7.5
7.5
7.5
For payment of periodic coupon interest: Disburse periodic coupon
interest to each tranche on the basis of the amount of principal
outstanding at the beginning of the period
For disbursement of principal payments: Disburse principal
prepayments to tranche A until it is paid off completely. After
tranche A is paid off completely, disburse principal payments to
tranche B until it is paid off completely. After … After tranche C is
paid off completely, disburse principal payments to tranche D until
it is paid off completely.
Fin431x (Ch 12, 13, 14, 15)
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Cash flow from Pass through
(page 277)
In month 1: total payment=$709,923;
Interest=$250,000
In month 81: total payment=
Fin431x (Ch 12, 13, 14, 15)
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Cash flow from the CMO
Exhibit 12-2 – split the principal; CMO
specifies the order of principal payment
The principal pay-down window
Average lives for the collateral and four
tranches of the CMO – page 279 (ex 12-3).
Fin431x (Ch 12, 13, 14, 15)
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Accrual Bond
One tranches (or more) does (do) not receive
current interest. This is an accrual tranche,
or Z bond.
Fin431x (Ch 12, 13, 14, 15)
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FJF-02
Tranche
A
B
C
Z
1.
2.
Par Amount
Coupon Rate(%)
194,500,000
7.5
36,500,000
7.5
96,500,000
7.5
73,000,000
7.5
?
For payment of periodic coupon interest
For disbursement of principal payments
3.
Solution: see Exhibit 5 – page 281.
Fin431x (Ch 12, 13, 14, 15)
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FJF-03: Floating-rate Tranches
Tranche
A
B
FL
IFL
Z
1.
2.
Par Amount
Coupon Rate(%)
194,500,000
7.5
36,500,000
7.5
72,375,000
1-month LIBOR + 0.50
24,125,000
28.5-3*(1-month LIBOR)
73,000,000
7.5
?
For payment of periodic coupon interest
For disbursement of principal payments
Fin431x (Ch 12, 13, 14, 15)
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Planned Amortization Class
(PAC)
Exhibit 12-8
Tranche
P
S
Par Amount
Coupon rate (%)
$243,800,000
7.5
156,200,000
7.5
400,000,000
For payment of periodic coupon interest
For disbursement of principal payments
Fin431x (Ch 12, 13, 14, 15)
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Principal Payments under PAC
Disburse principal payments to tranche P based on its
schedule of principal repayments. Tranche P has priority
with respect to current and future principal payments to
satisfy the schedule. Any excess principal payments in a
month over the amount necessary to satisfy the schedule
for tranche P are paid to tranche S. When tranche S is paid
off completely, all principal payments are to be made to
tranche P regardless of the schedule.
Fin431x (Ch 12, 13, 14, 15)
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Support Bonds
Bodyguards for the PAC bondholders
Can be partitioned into classes, I.e,
bodyguards have ranks and titles, too.
Fin431x (Ch 12, 13, 14, 15)
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Objective
To eliminate the contraction risk and the
extension risk
Contraction risk: when interest rate goes down
Extension risk: when interest rate goes up
Fin431x (Ch 12, 13, 14, 15)
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TAC
One-side prepayment protection.
Has a single PSA rate from which the
schedule of principal repayment is protected
Typically protected when prepayment is high,
thus avoid contraction risk.
Fin431x (Ch 12, 13, 14, 15)
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Credit Risk and Tax Treatment
of CMOs
Agency CMOs
Nonagency CMOs
Interest and principal payments are not taxable.
Fin431x (Ch 12, 13, 14, 15)
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Stripped Mortgage-Backed
Securities
Principal-only (PO) securities
when current mortgage rate < coupon rate, prepayment speeds up. 
price goes up
when current mortgage rate > coupon rate, price drops.
Interest-only (IO) securities
current mortgage rate < coupon rate, mixed
Exhibit 12-14 (page 296)
CMO strips: one class in CMO structure could be PO
or IO.
Fin431x (Ch 12, 13, 14, 15)
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Asset-backed Securities
Securities created by pooling loans other than first-lien
mortgage loans are referred to as asset-backed securities.
4 biggest sectors
• Credit card receivables
• Auto loans
• Home-equity loans
• Manufactured housing loans
Fin431x (Ch 12, 13, 14, 15)
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Cash flows of ABS
Amortizing assets
Amortization schedule
Absolute prepayment rate (APR)
Payment structure – page 334
Fin431x (Ch 12, 13, 14, 15)
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Credit Card ReceivableBacked Securities
Page 341.
Credit card issuers have receivables
IBs use the future cash flows from credit card
receivables as collaterals to issue ABS or
CDOs
Fin431x (Ch 12, 13, 14, 15)
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Collateralized Debt Obligations
A security backed by a diversified pool of one or more of the
following types of debt obligations
• U.S. domestic investment-grade and high-yield corporate
bonds
• U.S. domestic bank loans
• Emerging market bonds
• Special situation loans and distressed debt
• Foreign bank loans
• Asset-backed securities
• Residential and commercial mortgage-back securities
Fin431x (Ch 12, 13, 14, 15)
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Exercises (Ch12)
Problem 13: should be something close to 7.26 years
Problem 14: (a) support bond; (b) PAC bond
Problem 20: (a) 8.67%, (b) no effect , (c) more stable
cash flows and lower variability
Fin431x (Ch 12, 13, 14, 15)
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