One of two components (strips or tranches) of a mortgage-backed security (MBS) or other types of mortgage structured products (e.g., collateralized mortgage obligations or CMOs). The interest only tranche receives only the interest payments on the underlying security. In other words, the interest – only (IO) investor receives only monthly interest payment of the mortgage passthrough.
Interest onlys (also known as interest-only tranches, interest-only strips, etc.) increase in value when prepayment rates fall (as interest payment gets reduced due to a decrease in the principal amount), and vice versa. The market value of an interest only and the market value of a principal only or PO (the two tranches forming a mortgage-structured product) equal that of the underlying security.
