CMO stands for Collateralized mortgage obligation. CMO is a hedge instrument where a banks which has given several personal loans of different type, does not want to wait till the maturity to get that loan amount back, so it sells those collaterals to SPV (Special Purpose Vehicle) whose sole function is to securitize those collateral into a bond, called tranches. Tranche is German word which means slice. The collections of tranches are called deal. This deal is then sold to investors to invest on their risk appetite capability.Each tranches has unique 9 digits CUSIP (Committee on Uniform Security Identification Procedures) ID which is international recognised. These tranches has different type of payment methods for example interest only or principal only.
The formation of the CMO instrument can be seen in the figure-1. This shows how the loans collaterals are converted into a bond obligation. This kind of instrument is very less risky because these are backed by some assets. Each tranche is rated by the credit agencies based on the backed security and then handed over to underwriters. These credit rating agencies also enhance the credit of the Tranches by using certain tools and techniques. There are certain types of tranches which are supported by government.
