An interest-only bond (tranche) that receives the excess interest (difference between the coupon rate on the underlying tranches and the coupon payment on the collateral) on each underlying tranche’s remaining balance. The excess interest is no more being paid to the CMO residual (equity class). The holder of a notional interest only is entitled to receive varying strips of coupons from different tranches depending on the notional interest only structure. Notional interest only can be used to hedge positions in mortgage-backed securities (MBS) because when interest rates increase, the value of MBSs drops but the value of a notional interest only increases (for long positions), and vice versa (for short positions).
It is also called a structured interest only or for short a notional IO.
