Collateralized Mortgage Obligations (CMOs)
Chapters in this video
- 0:00 Why unpredictable homeowners wreck mortgage cash flows
- 0:48 Contraction risk vs extension risk
- 1:22 The exam trap: CMOs redistribute, never eliminate risk
- 1:53 Sequential-pay tranches and the champagne waterfall
- 2:30 PAC vs TAC: dual-sided vs one-sided protection
- 3:41 Companion tranches as the risk absorbers
- 4:34 Z-tranches and the 30/360 accrued interest rule
- 6:16 Rapid-fire exam recap
What this video covers
- Why CMOs redistribute prepayment risk across tranches but never eliminate it from the underlying mortgage pool
- The difference between contraction risk (rates fall, prepayments speed up) and extension risk (rates rise, prepayments slow)
- How sequential-pay tranches direct interest to all tranches but principal in order, shortening Tranche A's average life
- Why a planned amortization class (PAC) tranche has dual-sided protection and therefore the lowest yield in the structure
- Why a targeted amortization class (TAC) tranche only shields against contraction risk, leaving the holder exposed if rates rise
- How companion (support) tranches absorb the variable cash flows that keep PAC schedules predictable, and why they carry the highest yield
- Why Z-tranches (accrual tranches) accrue interest like a zero-coupon bond and have the longest average life, plus the 30/360 day count rule for CMO accrued interest
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