The principal-only portion of a mortgage loan or a mortgage-backed security (MBS). Financial institutions, especially mortgage financing firms, separate the principal from a mortgage loan and issue securities backed by the principal portion (known as POs). An owner of POs bets that interest rates will go down, whilst the issuer predicts an upward movement in rates.

Actually, a PO is a discount instrument since its price is just a fraction of its principal (20% or 30% for instance). If rates decrease, homeowners will repay their mortgages, and the holder of the PO receives the remaining percentage (80% or 70%) today, rather than after several years in the future. However, if rates move upward, and consequently homeowners refrain from prepaying, the PO’s holder might not receive any thing till maturity date (after 20 or 30 years).