Derivative Mortgage-Backed Securities

Mortgage-backed securities formed by dividing the cash flows from a pool of mortgages into obligations with payment characteristics substantially different from the underlying mortgages. Innovation in the mortgage market has led to numerous derivative mortgage instruments: the Collateralized Mortgage Obligation, consisting of a series of bonds with different maturity classes; theInterest Only (IO) Strip receiving only interest payments; the Principal-Only (PO) Strip a security receiving only loan principal payments; and mortgage Residuals which are the excess cash flow after debt service payments. Derivative securities often are used as hedging devices to immunize a loan portfolio against interest rate risk. See also Accrual Bond; Controlled Amortization Bond; Inverse Floater; Stripped Mortgage-Backed Securities.