COLLATERALIZED MORTGAGE OBLIGATION. A security backed by a pool of mortgage loans that may be separated into various classes with varying maturities. Note that REMICS, introduced by the Tax Reform Act of 1986, are the standard vehicle for investing in mortgage instruments.
Collateralised Mortgage Obligation. CMOs are bonds that are backed by a pool of mortgage pass-through securities or mortgage loans. These securities generally have stated maturities of fifteen to thirty years. These securities pay interest and principal on a monthly basis, just as individuals do when making their mortgage payments. For this reason, the purchaser will not necessarily hold them to the stated maturity. As people pay off their mortgages, this money is used to pre-pay the bonds. For this reason, bonds are described as having an "average life". The "average life" is the amount of time expected to repay the obligation, given certain interest rate expectations. Because there is some uncertainty as to when the bonds pay off, there is a substantial yield pick-up for purchasers. CMOs are most appropriate for income seeking investors that do not have a set time frame for the return of their principal and are looking for above market yields.