Structured Product

Agency CMO

 Agency CMO (Collateralized Mortgage Obligation): A type of mortgage-backed
security (MBS) where the collateral consists of mortgage loans issued or guaranteed by
government agencies like Fannie Mae, Freddie Mac, or Ginnie Mae.
 Tranche: A portion or slice of a CMO with varying levels of risk, maturity, and interest
rates. CMOs are divided into different tranches to meet the needs of various investors.
 Principal Payment: The portion of mortgage loan payments that goes toward reducing
the loan’s outstanding balance, passed through to investors in the CMO.
 Interest Payment: The portion of mortgage loan payments that goes toward interest,
distributed to investors in the CMO based on their tranche.
 Sequential-Pay Tranche: A CMO structure where tranches are paid in a specific order,
with earlier tranches receiving principal payments before later ones.
 Planned Amortization Class (PAC): A type of CMO tranche designed to provide more
predictable cash flows by using a schedule that reduces the risk of prepayment fluctuations.
 Targeted Amortization Class (TAC): A CMO tranche that focuses on providing
protection against prepayments, but with less certainty than a PAC.
 Support Tranche (Companion Tranche): A tranche that absorbs excess prepayments
or shortfalls, providing stability to PAC or TAC tranches.
 Prepayment Risk: The risk that homeowners will pay off their mortgages earlier than
expected, which affects the cash flow of CMO tranches.
 Extension Risk: The risk that mortgage prepayments will slow down, causing investors
to receive their principal payments later than expected, especially during periods of rising
interest rates.
 Pass-Through Securities: A type of MBS where principal and interest payments from
underlying mortgage loans are passed directly to investors. CMOs are more complex than
pass-throughs.
 Ginnie Mae: A government agency that guarantees MBS backed by federally insured or
guaranteed loans, often included in agency CMOs.
 Fannie Mae: A government-sponsored enterprise (GSE) that issues and guarantees
mortgage-backed securities, included in agency CMOs.
 Freddie Mac: Another GSE that issues and guarantees mortgage-backed securities,
contributing to agency CMOs.
 Collateral: The underlying pool of mortgage loans that back the CMO, often made up of
agency-guaranteed loans.
 Weighted Average Maturity (WAM): The average time until the principal of the
underlying mortgage loans is paid off, weighted by the loan amounts.
 Weighted Average Coupon (WAC): The average interest rate on the mortgage loans in
the pool, weighted by the loan amounts.

 Principal Only (PO) Securities: A CMO tranche that receives only the principal
payments from the underlying mortgages, and is sold at a discount.
 Interest Only (IO) Securities: A CMO tranche that receives only the interest payments
from the underlying mortgages, sensitive to prepayment rates.
 Yield Spread: The difference between the yield of the CMO tranche and a comparable
benchmark (e.g., Treasuries), which reflects the risk and return.
 Credit Risk: The risk that the borrowers in the underlying mortgage pool will default on
their loans. In agency CMOs, this risk is mitigated by the agency guarantee.
 Prepayment Model: A model used to estimate future prepayment rates for the
mortgages in the CMO, affecting the cash flow and value of the tranches.
 Call Protection: Features in a CMO structure designed to protect investors from early
prepayments, such as lockouts, prepayment penalties, or planned amortization schedules.
 Duration: A measure of the sensitivity of a CMO’s price to changes in interest rates, with
longer-duration tranches being more affected by rate changes.
 Cash Flow Waterfall: The order in which payments from the underlying mortgage pool
are distributed among the different tranches in a CMO.
 Accrual (Z) Tranche: A CMO tranche that does not receive any cash payments until
earlier tranches have been paid off, with interest accruing and added to the principal.
 Lockout Period: A period during which a CMO tranche does not receive any principal
payments, often used in sequential-pay structures.
 Secondary Market: The market where CMOs are bought and sold after issuance,
providing liquidity to investors.
 Securitization: The process of pooling mortgages or other loans and turning them into
securities (like CMOs) that can be sold to investors.
 Book-Entry System: A method of recording ownership of securities electronically, which
is commonly used for CMOs.

ABS

 Asset-Backed Security (ABS): A type of financial security backed by a pool of assets,
such as loans, leases, credit card receivables, or mortgages.
 Securitization: The process of pooling various types of debt (such as loans or
receivables) and issuing new securities backed by the cash flows from these assets.
 Collateral: The underlying assets (e.g., auto loans, credit card receivables) that back the
ABS and generate cash flows for investors.
 Tranche: A segment of the ABS offering that has a different level of risk, return, and
priority in the distribution of cash flows.

 Cash Flow: The stream of payments, typically from borrowers or lessees, which is used
to pay interest and principal to ABS investors.
 Credit Enhancement: Techniques used to improve the credit quality of an ABS, such as
over-collateralization, reserve accounts, or guarantees.
 Over-Collateralization: A form of credit enhancement where the value of the collateral
exceeds the amount of the ABS issued, reducing risk for investors.
 Reserve Account: A cash account set aside to cover any shortfalls in payments to ABS
investors, enhancing credit quality.
 Excess Spread: The difference between the interest collected on the underlying assets
and the interest paid to investors, often used to absorb losses.
 Default Risk: The risk that borrowers will not make their scheduled payments, affecting
the cash flows to ABS investors.
 Prepayment Risk: The risk that borrowers will repay their loans earlier than expected,
which can affect the returns to ABS investors.
 Amortization: The process of paying off the underlying loans in the ABS over time,
including both principal and interest.
 Pass-Through Security: A type of ABS where the cash flows from the underlying assets
are passed through directly to investors.
 Structured Finance: The sector of finance involved in creating complex financial
instruments, such as ABS, to redistribute risk.
 Subordination: A form of credit enhancement where lower-ranked tranches absorb
losses before higher-ranked tranches.
 Senior Tranche: The highest-rated tranche in an ABS, with the lowest risk of default but
usually the lowest return.
 Subordinate Tranche (Junior Tranche): A tranche that is paid after the senior tranche,
bearing higher risk but offering potentially higher returns.
 Interest Rate Risk: The risk that changes in interest rates will affect the value of the
ABS, particularly for fixed-rate securities.
 Liquidity Risk: The risk that the ABS will be difficult to sell or trade in the secondary
market.
 Rating Agency: A company (e.g., Moody’s, S&P, Fitch) that assigns credit ratings to ABS
based on the quality of the underlying assets and structure.
 Credit Rating: A rating assigned to the ABS that reflects the likelihood of timely payment
of interest and principal, with higher ratings indicating lower risk.
 Special Purpose Vehicle (SPV): A legal entity created to hold the assets in an ABS
transaction, separate from the originator’s balance sheet.
 Servicer: The entity responsible for collecting payments on the underlying loans or
receivables and distributing them to ABS investors.
 Issuer: The company or financial institution that structures the ABS and sells it to
investors.

 Pool Factor: The percentage of the original principal balance of the ABS that remains
outstanding at a given point in time.
 ABS Prospectus: A legal document that provides detailed information about the ABS,
including the structure, underlying assets, and risks.
 Underlying Assets: The loans, receivables, or other financial assets that back the ABS
and provide cash flows to investors.
 Auto Loan ABS: A type of ABS backed by auto loans, where the payments on these
loans are used to pay investors.
 Credit Card ABS: A type of ABS backed by credit card receivables, where payments on
credit card balances serve as the collateral.
 Student Loan ABS: A type of ABS backed by student loans, where loan payments are
passed through to investors.
 Home Equity Loan ABS: An ABS backed by home equity loans or lines of credit, often
included in residential mortgage-backed securities (RMBS).
 Lease-Backed ABS: ABS backed by lease payments, such as auto leases, which
provide regular cash flows to investors.
 Debt Service Coverage Ratio (DSCR): A ratio used to assess the ability of the
underlying assets in an ABS to generate sufficient cash flow to cover payments to investors.
 Yield Spread: The difference in yield between an ABS and a benchmark security,
reflecting the risk and return characteristics of the ABS.
 Call Provision: A feature that allows the issuer to redeem the ABS before its maturity,
often triggered by prepayments or other events.
 Revolving Structure: A type of ABS structure where new receivables or loans are added
to the pool as older ones are paid off, often seen in credit card ABS.
 Bullet Structure: A type of ABS where principal is paid back in a lump sum at maturity
rather than gradually over time.
 Lockout Period: A period during which principal payments are not made to investors,
typically seen in revolving ABS structures.
 Default Rate: The percentage of the underlying loans or receivables that are in default,
impacting the performance of the ABS.
 Payment Waterfall: The order in which payments are distributed to different tranches of
the ABS, with senior tranches being paid first.