Products & Their RisksQuestion 132 of 398
In a CMO, the different tranches primarily allow investors to:
a.Select a class with a prepayment and maturity profile matching their goals
b.Avoid all interest rate risk entirely
c.Convert the security into shares of common stock
d.Receive interest that is exempt from federal tax
Explanation
CMO tranches channel mortgage prepayments to different classes in a set order, so each tranche has a distinct average life and prepayment exposure. An investor wanting more predictable, shorter cash flows can choose an earlier tranche, while one seeking higher yield can accept a later, more prepayment-sensitive tranche. This structure tailors risk, but does not remove interest rate risk.
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