About MBS/ABS
Glossary
- Acrretion bond
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See Z-Tranche.
- Accrual bond
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See Z-Tranche.
- Accrued interest
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Interest deemed to be earned on a security but not yet paid to the investor.
- Active tranche
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A CMO tranche that is currently paying principal payments to investors.
- Amortization
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Liquidation of a debt through installment payments.
- Average life
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On a mortgage security, the average time to receipt of each dollar of principal, weighted by the amount of each principal payment, based on prepayment assumptions.
- Basis point
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One one-hundredth (.01) of a percentage point. Yield changes and differences among bonds are stated in basis points.
- Beneficial owner
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One who benefits from owning a security, even if the security’s title of ownership is in the name of a broker or bank.
- Bid price
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The price at which a buyer offers to purchase a security.
- Bond equivalent yield
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An adjustment to a CMO yield which reflects its greater present value, created because CMOs pay monthly or quarterly interest, unlike most types of bonds, which pay interest semiannually.
- Book-entry
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A method of recording and transferring ownership of securities electronically, thereby eliminating the need for physical certificates.
- Call risk
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For a CMO, the risk that declining interest rates may accelerate mortgage loan prepayment speeds, causing an investor's principal to be returned sooner than expected. As a consequence, investors may have to reinvest their principal at a lower rate of interest.
- Cap
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The maximum interest rate that may be paid on a floating-rate security.
- Clean CMO
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See Sequential-pay CMO.
- CMO (Collateralized Mortgage Obligation)
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A multiclass bond backed by a pool of mortgage pass-through securities or mortgage loans. See REMIC .
- CMT (Constant Maturity Treasury)
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A series of indexes of various maturities (one, three, five, seven, or ten years) published by the Federal Reserve Board and based on the average yield of a range of Treasury securities adjusted to a constant maturity corresponding to that of the index.
- COFI (Cost of Funds Index)
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A bank index reflecting the weighted average interest rate paid by savings institutions on their sources of funds. There are national and regional COFI indexes.
- Collateral
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Securities or property pledged by a borrower to secure payment of a loan. If the borrower fails to repay the loan, the lender may take ownership of the collateral. Collateral for CMOs consists primarily of mortgage pass-through securities or mortgage loans, but may also encompass letters of credit, insurance policies, or other credit enhancements.
- Companion tranche
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A CMO tranche that absorbs a higher level of the impact of collateral prepayment variability in order to stabilize the principal payment schedule for a PAC or TAC tranche in the same offering.
- Confirmation
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A document used by securities dealers and banks to state in writing the terms and execution of a verbal arrangement to buy or sell a security.
- Conventional mortgage loan
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A mortgage loan that is based solely on real estate as security, is not insured or guaranteed by a government agency and is eligibile for purchase or insurance by Fannie Mae or Freddie Mac.
- CPR (Constant Prepayment Rate)
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The percentage of outstanding mortgage loan principal that prepays in one year, based on an annualized Single Monthly Mortality (SMM), which reflects the outstanding mortgage loan principal that prepays in one month.
- Credit rating agency
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A company that analyzes the credit worthiness of a company or security, and indicates that credit quality by means of a grade, or credit rating.
- Current face
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The current remaining monthly principal on a mortgage security. Current face is computed by multiplying the original face value of the security by the current principal balance factor.
- CUSIP
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CUSIP numbers are unique nine-character alphanumeric identifiers assigned to each series of securities. The Committee on Uniform Security Identification Procedures was established by the American Bankers Association to develop a uniform method of identifying securities.
- Extension risk
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For a CMO, the risk that rising interest rates may slow the anticipated prepayment speeds, causing investors to find their principal committed longer than they expected. As a consequence, they may miss the opportunity to earn a higher rate of interest on their money.
- Face
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The principal amount of a security that appears on the face of the instrument. With mortgage securities, the amount of debt outstanding on the underlying mortgage loans.
- Factor
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A decimal value reflecting the proportion of the outstanding principal balance of a mortgage security, which changes over time, in relation to its original principal value.
- Floating-rate CMO
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A CMO tranche which pays an adjustable rate of interest tied to a representative interest rate index such as the London Interbank Offered Rate (LIBOR), the Constant Maturity Treasury(CMT), or the Cost of Funds Index (COFI).
- Floor
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The lower limit for the interest rate on a floating-rate security.
- Hedge
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A commitment or investment made with the intention of minimizing the impact of adverse price movements in an asset or liability, offsetting potential losses.
- Inverse floater
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A CMO tranche that pays an adjustable rate of interest that moves in the opposite direction from movements in a representative interest rate index such as the London Interbank Offered Rate (LIBOR), the Constant Maturity Treasury (CMT), or the Cost of Funds Index (COFI).
- IO (interest-only) security
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A security or tranche that pays only interest and not principal. IO securities are priced at a deep discount to the "notional" amount of principal used to calculate the amount of interest due.
- Issue date
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The date on which a security is deemed to be issued or originated.
- Issuer
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An entity obligated to pay principal and interest on a bond it issues.
- Jump Z-tranche
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A Z-tranche that may start receiving principal payments before prior tranches are retired if market forces create a "triggering" event, such as a drop in Treasury yields to a defined level, or a prepayment experience that differs from assummptions by a specific margin. "Sticky" jump Z-tranches maintain their changed payment priority until they are retired. "Non-sticky" jump Z-tranches maintain their priority only temporarily for as long as the triggering event is present. Although jump Z-tranches are no longer issued, some still trade in the secondary market.
- LIBOR (London Interbank Offered Rate)
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The rate banks charge each other for short-term eurodollar loans. LIBOR is frequently used as the base for resetting rates on floating-rate securities.
- Lockout
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The period of time before a CMO investor will begin receiving principal payments.
- Maturity date
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The date when the prinicpal amount of a security is due to be repaid, or the end of the life of a security.
- Mortgage
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A legal instrument that creates a lien upon real estate securing the payment of a specific debt.
- Mortgage loan
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A loan secured by a mortgage.
- Mortgage pass-through security
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A debt instrument representing a direct interest in a pool of mortgage loans. The pass-through issuer or servicer collects payments on the loans in the pool and "passes through" the principal and interest to the security holders on a pro rata basis. Mortgage pass-through securities are also known as mortgage-backed securities (MBS) and participation certificates (PC).
- Negative convexity
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A characteristic of CMOs and other callable or prepayable securities that causes investors to have their principal returned sooner than expected in a declining interest rate environment, and later than expected in a rising interest rate environment.
- Offer
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The price at which a seller will sell a security.
- Original face
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The face value or original prinicpal amount of a security on its issue date.
- PAC (planned amortization class) tranche
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A CMO tranche that uses a mechanism similar to a sinking fund to determine a fixed principal payment schedule that will apply over a range of prepayment assumptions. The effect of the prepayment variability that is removed from a PAC bond is transferred to a companion tranche.
- Par
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The principal amount of a bond due at maturity. With mortgage securities, the amount of debt outstanding on the underlying mortgage loans.
- Payment date
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The date that principal and interest payments are paid to the record owner of a security.
- P&I (prinicpal and interest)
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The term used to refer to regularly scheduled payments or prepayments of principal and of interest on mortgage securities.
- Plain-vanilla CMO
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See Sequential-pay CMO.
- PO (principal-only) security
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A tranche or security that pays investors principal only and not interest. PO securities are priced at a deep discount from their face value.
- Pool
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A collection of mortgage loans assembled by an originator or master servicer as the basis for a security. In the case of Ginnie Mae, Fannie Mae or Freddie Mac mortgage pass-through securities, pools are identified by a number assigned by the issuing agency.
- Prepayment
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The unscheduled partial or complete payment of the principal amount outstanding on a mortgage loan or other debt before it is due.
- Price
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The dollar amount to be paid for a security, which may also be stated as a percentage of its face value or par in the case of debt securities.
- Principal
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The face amount of a bond, payable at maturity. With mortgage securities, the amount of debt outstanding on the underlying mortgage loans.
- Private Label
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The term used to describe a mortgage security whose issuer is an entity orther than a U.S. government agnecy or U.S. government-sponsored enterprise. Such issuers may be banks, subsidiaries of investment banks, other financial institutions, or home builders, for example.
- Pro rata
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Proportional distribution to all holders of the same class, based on ownership.
- Ratings
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Designations used by credit rating agencies to give relative indications as to opinions of credit quality.
- Record date
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The date for determining the owner entitled to the next scheduled payment of principal or interest on a mortgage security.
- REMIC (Real Estate Mortgage Investment Conduit)
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A pass-through investment vehicle which issues multiclass mortgage-backed securities that have certain tax and accounting advantages for issuers and investors due to the Tax Reform Act of 1986. Currently, most CMOs are issued in REMIC form and the terms "REMIC" and "CMO" are now used interchangeably.
- Residual
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A tranche which collects any cash flow from the collateral that remains after obligations to all the other tranches have been met.
- Scenario analysis
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An analysis examining the likely performance of an investment under a wide range of possible interest rate environments.
- Sequential-pay CMO
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The most basic type of CMO. All tranches receive regular interest payments, but principal payments are directed initially only to the first tranche until it is completely retired. Once the first tranche is retired, the principal payments are applied to the second tranche until it is fully retired, and so on. Also known as a 'plain vanilla' or 'clean' CMO.
- Servicing
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The collection and pooling of principal, interest and escrow payments on mortgage loans and mortgage securities; accounting; bookkeeping; insurance; tax records; loan payment follow-up; delinquency loan follow-up; and loan analysis. The party providing these servies receives a fee, the servicing fee, as compensation.
- Servicing fee
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The amount retained by the mortgage servicer from monthly interest payments made on a mortgage loan.
- Settlement date
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The date for the delivery of bonds and payment of funds agreed to in a transaction.
- Sinking Fund
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Money set aside by an issuer of bonds on a regular basis, for the specific purpose of redeeming debt. Bonds with such a feature are known as "sinkers."
- SMM (Single Monthly Mortality)
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The percentage of outstanding mortgage loan principal that prepays in one month.
- Standard Prepayment Model (SIFMA prepayment model)
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A model based on historical mortgage prepayment rates used to estimate prepayment rates on mortgage securities. SIFMA’s model is based on the Constant Prepayment Rate (CPR), which annualizes the Single Monthly Mortality (SMM), or the amount of outstanding principal that is prepaid in a month. Projected and historical prepayment rates are often expressed as “percentage of PSA” (Prepayment Speed Assumptions). A prepayment rate of 100% PSA implies annualized prepayment rates of 0.2% CPR in the first month, 0.4% CPR in the second month, 0.6% CPR in the third month, and 0.2% increases in every month thereafter until the thirtieth month, when the rate reaches 6%. From the thirtieth month until the mortgage loan reaches maturity, 100% PSA equals 6% CPR.
- Super PO
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A principal-only security structured as a companion bond.
- Superfloater
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A floating-rate CMO tranche whose rate is based on a formulaic relationship to a representative interest rate index.
- Support tranche
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See Companion tranche.
- TAC tranche
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Targeted amortization class tranche. A TAC tranche uses a mechanism similar to a sinking fund to determine a fixed principal payment schedule based on an assumed prepayment rate. The effect of prepayment variability that is removed from the TAC tranche is transferred to a companion tranche.
- Toggle tranche
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See Jump Z-tranche.
- Tranche
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A class of bonds in a CMO offering. "Tranche"is the French word for "slice."
- Transfer agent
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A party appointed to maintain records of securities owners, to cancel and issue certificates, and to address issues arising from lost, destroyed or stolen certificates.
- Trustee
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An entity designated by the issuer as the custodian of funds and official representative of bondholders. Trustees are appointed to ensure compliance with the trust indenture and represent bondholders to enforce their contract with the issuers.
- Weighted average coupon (WAC)
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The weighted average interest rate of the underlying mortgage loans or pools that serve as collateral for a security, weighted by the size of the principal loan balances.
- Weighted average loan age (WALA)
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The weighted average number of months since the date of the origination of the mortgages (i.e., the age of the loans) that collateralize a security, weighted by the size of the principal loan balances.
- Weighted average maturity (WAM)
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The weighted average number of months to the final payment of each loan backing a mortgage security weighted by the size of the principal loan balances. Also know as weighted average remaining maturity (WARM) and weighted average remaining term (WART).
- Window
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In a CMO security, the period of time between the expected first payment of principal and the expected last payment of principal.
- Yield
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The annual percentage rate of return earned on a security, as computed in accordance with standard industry practices. Yield is a function of a security’s purchase price and interest rate.
- Z-tranche
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Often the last tranche in a CMO, the Z-tranche receives no cash payments for an extended period of time until the previous tranches are retired. While the other tranches are outstanding, the Z-tranche receives credit for periodic interest payments that increase its face value but are not paid out. When the other tranches are retired, the Z-tranche begins to receive cash payments that include both principal and continuing interest.
All information and opinions contained in this publication were produced by the Securities Industry and Financial Markets Association from our membership and other sources believed by the Association to be accurate and reliable. By providing this general information, the Securities Industry and Financial Markets Association makes neither a recommendation as to the appropriateness of investing in fixed-income securities nor is it providing any specific investment advice for any particular investor. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and sources may be required to make informed investment decisions.