A CMO (collateralized mortgage obligation) is a structured product that is backed and collateralized by a pool of mortgage loans and similar debt arrangements. It is a type of mortgage-backed security (MBS) that consists of a collection of mortgages packaged together and sold to investors (in which case, the investors/ lenders or holders of the securities) as one unit. These underlying assets of the mortgage loans (e.g., mortgaged assets) provide a collateral if the loan ends up in default (in case the borrower runs into default on payment/ repayment). The proceeds collected from the pool of mortgages will be used to service the debt embodied in the securities held by the investors (the lenders).

A CMO is a customized security in the sense that it can be tailor-made to meet the requirements of different investors. CMOs are usually sliced into tranches or classes of bonds which are structured in accordance with the preferences and needs of individual or institutional investors in terms of their desired repayment risk (the uncertainty that the timing of the actual cash flows from the pool of underlying collateral securities will diverge from the planned cash flows due to the borrowers’ ability to prepay their debts, in an attempt to take advantage of interest rate movement.).