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Bonds 203: Collateralized Mortgage Obligations

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1.
Collateralized mortgage obligations divide mortgages into tranches based on _______.
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The repayment schedule. Tranches are based on when the mortgages are scheduled to be repaid.
2.
Companion bonds are safest when interest rates rise.
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True. Since more mortgages are prepaid when interest rates fall, rising interest rates reduce the prepayment risk of companion bonds.
3.
Income from a CMO mortgage pool is applied to the latest-maturing bonds first.
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False. Income from a CMO mortgage pool is applied to the earliest-maturing bonds first.
4.
Compared to other pass-throughs, collateralized mortgage obligations offer higher returns and lower risk.
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False. While CMOs do offer lower prepayment risk than other pass-throughs, their returns are often lower as a result.
5.
_________ pay higher returns for accepting higher prepayment risk.
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Companion bonds. Since these are paid off first when underlying mortgages are prepaid, they absorb more prepayment risk and typically pay higher interest rates.