Test your knowledge

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Collateralized mortgage obligations are issued by Ginnie Mae.

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True

False

False. CMOs are issued by the Federal Home Loan Corporation (FHLMC), or Freddie Mac.

_________ pay higher returns for accepting higher prepayment risk.

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CMOs

PACs

Companion bonds

Companion bonds. Since these are paid off first when underlying mortgages are prepaid, they absorb more prepayment risk and typically pay higher interest rates.

Collateralized mortgage obligations divide mortgages into tranches based on _______.

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The repayment schedule

Interest rates

Default risk

Maturity date

The repayment schedule. Tranches are based on when the mortgages are scheduled to be repaid.

Companion bonds are safest when interest rates rise.

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True

False

True. Since more mortgages are prepaid when interest rates fall, rising interest rates reduce the prepayment risk of companion bonds.

Which of the following is an investment benefit of collateralized mortgage obligations?

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Low tax rates

Higher yields than those of other pass-throughs

Inflation protection

Higher potential than that of US Treasury bonds

Higher potential than that of US Treasury bonds. The other features are not characteristic of CMO bonds.

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