A collateralized mortgage obligation (CMO) is a debt identity that manages debt separately from the entities that established it. Mortgages are pooled to create bonds, called tranches, with defined rules and terms for investors. CMOs are used for high-priced properties and by banks, insurance companies, hedge funds, and government agencies.
The collateralized mortgage obligation is a special purpose debt identity that is created as a means of managing debt in an entity that is completely separate from the entities that established the debt in the first place. As such, the collateralized mortgage obligation assumes ownership of the debts included in the strategy. Debts can include one or more different types of mortgages.
Part of the collateralized mortgage obligation, or CMO, structure is understanding that all of the individual mortgages included in the entity are considered a pool. This combined mortgage pool provides the basis for investors to purchase bonds that are issued based on the strength of the pool. When bonds are issued in groups of mortgages, the bonds are called tranches.
Each secured mortgage obligation will be configured with a defined set of rules. The rules, known as the structure, will dictate the type of mortgages that can be included in the CMO, the procedure for receiving money in the obligation, and how it will be distributed to investors. The structure will also specify the terms and conditions necessary for the issuance and acquisition of bonds. Within this type of financial agreement, it is understood that the mortgages themselves provide the guarantee for the bond issue.
The actual use of a collateralized mortgage obligation is generally associated with high-priced mortgages, and is not used as often with smaller residences. However, public buildings, such as municipal facilities, shopping malls, and high-rise office buildings, are examples of properties that can be financed with a mortgage secured by a CMO in an investment grade bond.
Several different types of companies are engaged in the use of a secured mortgage obligation. Banks and insurance companies are two excellent examples of corporations that make use of this type of financial entity. The CMO can also be used in the function of hedge funds, pensions and mutual funds. Government agencies can also make use of the collateralized mortgage obligation.
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