McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER20CHAPTER20 CHAPTER20CHAPTER20 The Secondary Mortgage Market: CMOs and Derivative.

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McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER20CHAPTER20 CHAPTER20CHAPTER20 The Secondary Mortgage Market: CMOs and Derivative Securities

20-2 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Secondary Mortgage Market Mortgage Pay-Through Bonds  Bond, not an equity ownership interest  Debt obligation of issuer  Interest paid a coupon rate of interest like MBB  Pass-through of principal like MPT  Over collateralized like MPT

20-3 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Secondary Mortgage Market Collateralized Mortgage Obligations  Debt instrument  Mortgage pool owned by issuer  Overcollateralization  Pass-through of principal & interest  Multiple classes of securities issued Different maturity classes Different priority for payment of principal and interest Tranches

20-4 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Secondary Mortgage Market Collateralized Mortgage Obligations  Sequential Payout Tranche Structure Tranche Z: Paid Last Tranche A: Principal, Prepayments, & Interest Received First Tranche B: Interest Only Until Tranche A is Paid Etc. for any additional tranches

20-5 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Contents of a CMO Offering with Sequential Pay Tranches

20-6 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Annual Cash Flows into CMO Mortgage Pool

20-7 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

20-8 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

20-9 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Annual Cash Flows to Tranches (Prepayment = 0%)

20-10 Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved Annual Cash Flows to Tranches (Prepayment = 10%)