Why are truanches slow?

1. What are two risks that a CMO investor faces?
2. Which tranche has the most prepayment risk?
3. Do PACS have extension risk?
4. Are CMOs a good investment?
5. Are CMOs securitized?
6. Why is prepayment bad?
7. How do prepayments affect weighted average life?
8. What CDO means?
9. Are CMOs taxed?
10. Are CMOs backed by the government?
11. What is AZ tranche?
12. Do CMOs have credit risk?
13. Is GNMA an FHA?
14. What happens to principal only CMOs when interest rates decrease?

What are two risks that a CMO investor faces?

Risks to CMO investors include the possibility that all payments won't be made on time, loss of premium due to prepayments, market risk when interest rates rise, and prepayment and extensions when principal is returned earlier or later than expected.

Which tranche has the most prepayment risk?

Planned amortization class (PAC) tranches: This type of CMO is the most common because it has the most certain prepayment date. The prepayment and extension risk can be somewhat negated by a companion tranche, which assumes a greater degree of the risk.

Do PACS have extension risk?

The Limits of PAC Tranche Protection

The measure of repayment risk protection, which includes both contraction and extension risk, is limited by the size of the companion bond and the speed of repayment. If the speed of repayment is too slow (below the lower PAC collar), the life of the PAC tranche is extended.

Are CMOs a good investment?

All investments come with risk. But CMOs are relatively safe investments because many of the mortgage loans in CMOs are insured by large mortgage investors such as Ginnie Mae, Fannie Mae or Freddie Mac. These loans, because of the agencies insuring them, generally carry a lower risk of default.

Are CMOs securitized?

The development of the CDO filled a void and provided a valid way for lending institutions to essentially move debt into investments through securitization, the same way mortgages were securitized into CMOs.

Why is prepayment bad?

Why Does Prepayment Risk Matter? When a borrower prepays a loan, the borrower saves a lot of interest. But that means the lender also misses out on all that interest. Accordingly, prepayment can sometimes come with a penalty, and this is disclosed in the loan documents.

How do prepayments affect weighted average life?

Prepayments reduce WAL, meaning less interest income is earned over the life of the bond, and that life is shortened by each prepayment.

What CDO means?

A collateralized debt obligation (CDO) is a complex structured finance product that is backed by a pool of loans and other assets and sold to institutional investors. ... These assets become the collateral if the loan defaults.

Are CMOs taxed?

The interest portion of payments to CMO investors is subject to federal, state, and local income tax. ... Any portion of the CMO payment that represents return of principal or original cost is not taxable.

Are CMOs backed by the government?

Some CMOs are guaranteed by the Government National Mortgage Association (GNMA or Ginnie Mae), and agency of the U.S. government or by U.S. government sponsored enterprises such as the Federal National Mortgage Association (FNMA or Fannie Mae) or the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac).

What is AZ tranche?

A Z tranche is a CMO tranche. With the exception of jump Z tranches, owners of the Z tranche receive no cash flow from underlying mortgage collateral until the other tranches are retired. During the period when other tranches are still outstanding, the owners of the Z tranche receive credit for periodic interest.

Do CMOs have credit risk?

Whole loan CMOs are subject to both credit risk and interest rate risk. Issuers of whole loan CMOs generally structure their deals to reduce the credit risk of all certain classes of bonds ("Senior Bonds") by utilizing various forms of credit protection in the structure of the deal.

Is GNMA an FHA?

Not just any loan comes with this airtight guarantee. Ginnie Mae MBSs are insured by the Federal Housing Administration (FHA), which typically provides mortgages for low-income and first-time home buyers, among other underserved groups.

What happens to principal only CMOs when interest rates decrease?

If interest rates drop, then prepayments will increase, as homeowners refinance to get a lower interest rate, thereby shortening the life of the tranche. The investor gets less than expected, and may not be able to reinvest for a comparable interest rate and risk, called reinvestment risk.