Since mortgages allow for prepayment, there is no assurance how much interest will actually be paid. However, Z-tranches can be structured with intermediate-term average lives as well. After the first payment is received, future payments are made monthly or quarterly.The most basic CMO structure is made up of tranches that pay in   a strict sequence. A CMO is essentially a way to create many different kinds of bonds from the same mortgage loan so as to please many different kinds of investors. Securitizing assets creates a new, more liquid tradeable financial asset, which can be used to provide funding for a wide range of consumer and business credit  needs.Securitizations typically rely on the cash flows generated by the underlying financial assets for the repayment of investors, as opposed to the general credit or the claims-paying ability of an operating entity.Cash flows generated by the securitized assets can be structured, or Asset-backed securities collateralized by residential mortgage loans are called residential “mortgage-backed securities”  (MBS).A residential MBS is a fixed-income security, collateralized by residential mortgage loans that finance the purchase or the refinancing of homes or other real estate. negative duration). The different classes of securities in a CMO offering are known as tranches, from the French word for “slice.” The CMO structure enables the issuer to direct the principal and interest cash flow generated by the collateral to the different tranches in a prescribed manner in order to meet different investment  objectives.In structuring a CMO, an issuer distributes cash flow from the underlying collateral over a series of classes, or tranches, which constitute the bond issue.
Mortgage- backed security yields are often quoted relative to yields on Treasury securities with maturities closest to the mortgage-backed security’s estimated average life. On the other hand, if prepayments decelerate, the value of the PO will drop. However, as demand for mortgage credit grew in the post-World War II era, portfolio lending was insufficient to keep pace with this demand, leading to the development of the MBS market.The modern era of mortgage securitization began when the first MBS was issued in 1970, guaranteed by the Government National Mortgage Association (GNMA, or “Ginnie Mae”). In the United States, the MBS market is crucial to both the availability and affordability of housing. The mortgage-backed securities market also includes “private-label” mortgage securities issued by such as subsidiaries of investment banks, financial institutions, and real estate investment trusts – issue MBS not guaranteed by Ginnie Mae, Fannie Mae, or Freddie Mac.Collateralized Mortgage Obligations (CMO) is a multi-class security backed by a pool of mortgage pass-through securities and/or mortgage loans. NAS bonds are designed to protect investors from volatility and negative convexity resulting from prepayments. Because the interest on these securities is taxable when it is credited, even though the investor receives no interest payment, Z-tranches are often suggested as investments for tax-deferred accounts.Some mortgage-backed securities are created so that investors receive only principal payments generated by the underlying collateral; the process of separating the interest payments from the principal payments is called   “stripping”.The market values of POs are extremely sensitive to prepayment rates. Mortgage lenders must apply to Ginnie Mae for approval to issue securities under its programs and for its commitment to guaranty  a specific amount of securities. The borrower typically repays the mortgage loan in monthly installments.
Since the IO tranche has negative duration, a PO typically has more effective duration than its collateral. When prepayments are heavy, the PAC tranche pays only the scheduled amount, and the companion class absorbs the excess.Type I PAC tranches maintain their schedules over the widest range of actual prepayment speeds, for example from 100% to   300% of the PAC tranches are a common type of CMO tranche. Upon approval, Ginnie Mae authorizes its transfer agent to create and deliver Ginnie Mae-guaranteed securities. The ability to securitize mortgage loans gives lenders access to global sources of capital, making financing available to home buyers at lower costs, and promoting  a national market for mortgage loans with broader availability of affordable credit than would be otherwise  possible.Characteristics of the mortgage loans that collateralize MBS vary. If mortgage prepayments increase, or the market's expectations of future prepayments increases (i.e. Industry standard and various  proprietary  prepayment  rate  models exist and are used by investors to value investments in MBS. While IO and PO tranches have different risk characteristics, neither the IO nor the PO represents a leveraged position in the underlying collateral pool. Some classes receive less risk of a particular type; other classes more risk of that type. In CMOs backed by loans of lower credit quality, such as If the "overcollateralization" turns into "undercollateralization" (the assumptions of the default rate were inadequate), then the CMO defaults. The tranche receiving principal repayment is referred to as Depending on when the CMO transaction settles, the investor may have to wait up to two months for the first payment; this delay is factored into the yield quoted at the time of purchase. Salomon Brothers and First Boston created the CMO concept to address these issues. Another way to enhance credit protection is to issue bonds that pay a lower interest rate than the underlying mortgages.

Typically, a mortgage borrower can prepay the mortgage loan at any time by selling the property, refinancing the mortgage, or simply paying off the loan in part or  in full. The floater coupon is allocated to the premium fixed rate tranche principal, in the example the $75mm '8 off 6', giving the floater tranche of '$75mm 8% cap + 40bps LIBOR SEQ floater'.