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What is a Collateralized Mortgage Obligation?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 25 September 2016
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The collateralized mortgage obligation is a special purpose debt identity that is created as a means of handling debt in an entity that is entirely separate from the entities that established the debt in the first place. As such, the collateralized mortgage obligation assumes the ownership of the debts included in the strategy. The debts may include one or more different types of mortgages.

Part of the structure for the collateralized mortgage obligation, or CMO, is understanding that all the individual mortgages included in the entity are considered to be a pool. This combined mortgage pool provides the basis for investors to buy bonds that are issued on the strength of the pool. When bonds are issued on mortgage pools, the bonds are referred to as tranches.

Each collateralized mortgage obligation will be configured with a definite set of rules. The rules, known as the structure, will dictate the type of mortgages that may be included in the CMO, the procedure for receiving money into the obligation and how it will be distributed to the investors. The structure will also specify the terms and conditions necessary for the issuing and acquisition of bonds. Within this type of financial arrangement, the mortgages themselves are understood to provide the collateral for the bond issue.

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The actual use of a collateralized mortgage obligation is usually associated with high priced mortgages, and not as often employed with smaller residences. However, public buildings such as municipal facilities, shopping malls, and high rise office buildings are all examples of properties that may be financed with a mortgage included as collateral in a CMO in an investment-grade bond.

A number of different types of businesses engage in the use of a collateralized 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 utilized in the function of hedge funds, pensions, and mutual funds. Government agencies may also make use of the collateralized mortgage obligation as well.

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