Collateralized Mortgage Obligation. A mortgage-backed, investment-grade bond that separates mortgage pools into different maturity classes. Collateralized mortgage obligations (CMO) are backed by mortgage-backed securities with a fixed maturity. They can eliminate the risks associated with prepayment because each security is divided into maturity classes that are paid off in order. As a result, they yield less than other mortgage-backed securities. The maturity classes are called tranches, and they are differentiated by the type of return.
A given tranch may receive interest, principal, or a combination of the two, and may include more complex stipulations. One negative aspect of collateralized mortgage obligations is the lower interest rates that compensate for the reduction in prepayment risk and increased predictability of payments. Also, collateralized mortgage obligations can be quite illiquid, which can increase the cost of buying and selling them.

Use CMO in a sentence

My investment bank nearly went under during the Great Recession, because many of the mortgages we were trying to put together into a mortgage bond CMO all went bad at the same time.

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We had to take a look at the CMO, but I didn't want to, so I had my associate do it instead.

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You should try and get as good of a deal as you can any time you will be entering into a CMO in the future.

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plain-vanilla CMO collateralized debt obligation