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Brodie Johnson of Merrill Lynch - Understanding Collateralized Mortgage

Obligations
Brodie Johnson served as the Head of Residual Trading at Bank of America, and Merrill
Lynch, although he was never a stockbroker. He grew up in Princeton, New Jersey and
attended Montgomery High School. He graduated cum laude with a double major in
English and Philosophy from Amherst College in 1980. He has over 35 years experience
in investment banking and bond trading. He developed and implemented the reverse
REMIC which played an important role in restoring
liquidity to the CMO market after the 2008 financial crisis. Collateralized Mortgage
Obligation The collateralized mortgage obligation (CMO) is a mortgage-backed security
where principle repayments are arranged according to their maturities into various classes
based on risk. A CMO is a special purpose entity that owns the mortgages and receives
cash flow and mortgage repayments from it. The income received from the mortgages are
paid out to investors based on a prearranged set of rules. Investors receive payouts from
the specific slice (tranche) of mortgages they have invested in. CMOs are complex
financial instruments and each CMO can have different interest rates, principal balances,
repayment risks, and maturities. CMOs are sensitive to any changes in the interest rates
including other economic conditions such as refinance rates, property sales rate, and
foreclosure rates. Those investing in collateralized mortgage obligations seek to acquire
access to mortgage cash flows without having to purchase a set of mortgages. Firms and
organizations that purchase CMOs include banks, mutual funds, hedge funds, and
insurance companies. There are different types of CMO tranches, they are;

Planned Amortization Class Tranche (PAC) It is the most common type of CMO
as it has a definite prepayment date, but has the lowest yield.

Targeted Amortization Class Tranche (TAC)

Companion Tranche - These are included in every CMO that has TAC or PAC
tranches. Companion tranches absorb the prepayment risks related to CMOs.
They also have higher yields.

Targeted Amortization Class Tranche (TAC)


It has a less definite principle payment and is subject to extension and prepayment
risk.

Companion Tranche
These are included in every CMO that has TAC or PAC tranches. Companion
tranches absorb the prepayment risks related to CMOs. They also have higher
yields.

Z-Tranches - They have the longest maturity in PAC or companion tranches;


however, they generally dont receive any principal or interest until all the other
tranches have been retired.

Principle-Only Tranches (PO) - They are purchased at a deeply discounted price,


below face value, and investors receive par value through scheduled mortgage
payments and prepayments. Interest-Only Tranches (IO). CMOs with principleonly tranches have interest-only tranches. Interest-only tranches are sold at prices
far below their expected value.

Floating Rate Tranches -These appear with CMOs where the interest rates are
connected to an interest rate index, e.g. London Interbank Offered Rate (LIBOR).
Brian Johnson served at Merrill Lynch and has experience in bond trading.
Source: http://www.investopedia.com/terms/c/cmo.asp