A mortgage-backed security (MBS) is a security (specifically, a type of asset-backed security, ABS) which is secured by a mortgage or pool of mortgages. The mortgages are aggregated and sold to an entity that securitizes or packages them together into marketable securities (by means of securitization) that are then sold to investors.

A lender (mortgagee) combines its mortgages into a bundle and then divides it into specific shares/ slices (shares in the pool). An investor is entitled to receive a portion of the principal (as repayment) and interest payments on the underlying mortgages.

The most common types of mortgage backed securities (MBSs) are:

• Pass-throughs (pass through securities).
• Collateralized mortgage obligations (CMO).
• Stripped mortgage-backed securities.

Pass-throughs (PTs) are set up and structured as trusts through which mortgage payments are collected and passed directly to investors.

Collateralized mortgage obligations (CMOs) are more complex debt instruments, consisting of multiple packages of securities divided and bundled into fractional tranches. Each tranche is featured by its own structure, yield, credit profile (and its ow credit rating), and hence is sold separately to institutional investors, such as investment banks, insurance firms, pension funds, mutual funds and hedge funds, as well as government agencies and central banks.

Stripped mortgage-backed securities (stripped MBS) are created by creating two or more cash flow streams from a pool of mortgages, each distinguished by its own risk and return profile. The most popular streams include 1) a stripped MBS is an interest-only security (IO), which receives only the interest payments from the underlying mortgages and 2) a principal-only security (PO), which receives only the principal payments.