Question

What are the differences between a pass-through security and a collateralized mortgage obligation (CMO)?

Answer 1

1. A pass through security is simple pass through of cash flows from borrower to the investor significantly exposing investor to prepayment risk, extention risk and credit risk while a collateralised mortgage obligation is a derivative created through pass through to address prepayment risk by redistributing it through PAC tranches

2. The structure of pass through security is like bonds while the essence of Collateralised mortgage obligation is a structured instrument which can be used as a hedge for cash flows.

3.One of the difference between CMO and A pass through security is that In CMO structure, Many different securities are created from the pool of mortgages by redirecting the cash flows of principal and interest, While In a Pass through security the cash flows are not redirected using PAC tranches.

4.Another difference between the two is that Pass through security investors get their percentage of cash flows from the amount of securities they own as a percentage of whole pool, While, CMO investors get their cash flows on the on the basis of priority in buying the tranche of the bond.