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The following information is for a collateralized mortgage obligation (CMO). Tranche A has a face value...

The following information is for a collateralized mortgage obligation (CMO). Tranche A has a face value of $50 million and pays 6 percent annually. Tranche B has a face value of $50 million and pays 8 percent annually. All mortgages have maturities of 30 years.

a. What are the annual payments promised to Tranche A and Tranche B, respectively, assuming no prepayments and non-amortization?

b. If at the end of the first year, the trustee of the CMO receives total cash flows of $10 million, how are they distributed to Tranche A and B, respectively?

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Answer #1

a) Annual payments promised to Tranche A = Face value * interest rate

= $50 million*6% = $3 million

Annual payments promised to Tranche B = Face value * interest rate

= $50 million*8% = $4 million

b) CMOs distribute principal and interest payments to their investors based on predetermined rules and agreements.

Since in this question interest has to pay annually, so $3 million & $4 million is distributed to Tranche A & B respectively as interest payment. Balance of $3 million ($10million-$7million) will be adjusted against principal based on terms & agreement.

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