In a discussion of the CMO market, the popular press sometimes refers to this sector of the mortgage-backed securities market as the riskiest sector and the pass-through sector as the safest sector. Comment
What will be an ideal response?
Collateralized mortgage obligations derive their cash flow from underlying mortgage collateral such as pass-throughs or a pool of whole loans. Thus, CMOs can be referred to as a derivative mortgage-backed securities product. The popular press does not always distinguish between the speculative and hedging nature of derivatives but perceive derivatives as riskier due to greater variability in outcomes that often result. On the other hand, many pass-throughs are sponsored by government agencies and thus perceived as being safe. Thus, the popular press can erroneously mistake differences in overall or total risk when speaking of the CMO sector and the
pass-through sector. The fact is CMOs are backed by pass-throughs and thus the total risk of each sector should be the same.
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