Types of Mortgage-Backed Securities

Mortgage-backed securities—also known as mortgage pass-through securities, because the income from the underlying pool of loans is passed 

A collateralized mortgage obligation, or CMO, differs from a passthrough in that the underlying mortgj e pool is separated into different maturity classes, or tranches, and the cash flow distributions to investors are prioritized based on the class of the tranche they hold. It is possible to have two tranches of the same rating, but one more senior than the other. Typically, each tranche also pays a different interest rate and appeals to a different class of investors. 

All classes of a single CMO receive an equal share of the interest payments it is the principal repayments received that differ. Consider an issue with a nominal value of 100 million, 60 million of which is allocated to the class A tranche, 25 million to the class B, and the rest to class C. Holders of class A bonds receive all the principal repayments until the bonds retire, after which class B holders get all the repayments, and so on. The class A bonds thus have the shortest maturity and the highest credit rating, and the class C bonds the longest and usually the lowest. A level of uncertainty is still associated with the maturity of each bond, but it is lower than that associated with a pass-through security. CMOs are discussed in more depth following. 

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