Glossary of Terms

Collateralised Mortgage Obligations (CMOs) –The CMO is a multi-class bond backed by a credit risk – The risk that the underlying borrower on the mortgage defaults on his mortgage payment either in part or in whole, which would result in a loss on the investment.

Credit Risk – The risk that the underlying borrower on the mortgage defaults on his mortgage payment either in part or in whole, which would result in a loss on the investment.

FHLMC (Federal Home Loan Mortgage Corporation) – Freddie Mac is chartered by Congress, but owned by stockholders. Freddie Mac guarantees timely payment of both principal and interest on its Gold PCs. Some older series of Freddie Mac PCs guarantee timely payment of interest and eventual payment of principal.

Floating-Rate or Adjustable-Rate Coupon – A coupon payment on a mortgage that adjusts to changes in an index, generally a short-term interest rate benchmark such as Libor (London Inter Bank Offered Rate) or the CMT (Constant Maturity Treasury), at a predetermined spread to that index. (e.g.; if Libor equals 6% and the spread equals 1% then the resulting coupon equals 7%.)

FNMA (Federal National Mortgage Association) – Fannie Mae is chartered by Congress, but owned by stockholders. Fannie Mae guarantees timely payment of both principal and interest on its mortgage securities whether or not the payments have been collected from the borrower.

GNMA (Government National Mortgage Association) – Ginnie Mae is a Government-owned corporation within the Department of Housing and Urban Development. Ginnie Mae guarantees the timely payment of principal and interest on all of its pass-through securities, and Ginnie Mae’s guarantee is backed by the full faith and credit of the US Government. This guarantees prompt payment of monthly interest, whether or not mortgage payments are collected, and full repayment of principal even if the mortgages in the pool default.

IO (Interest Only) – Represents the right to receive 100% of the interest payment and zero of the principal payment on the mortgages.

Money Centre Bank – A bank in one of the world’s major financial centres, such as London, Tokyo or New York, that is a large lender, money market buyer and securities purchaser. A money centre bank also lends money to governments and international corporations.

Mortgage-Backed Securities – An ownership interest in mortgage loans made by financial institutions (savings & loans, commercial banks, or mortgage companies) to finance a borrower’s purchase of a home or other real estate. Investors may purchase mortgage securities either when they are issued or afterward in the secondary market from a dealer.

Pass-throughs – or participation certificate (PC) – These are the most basic mortgage securities, which represent a direct ownership interest in a pool of mortgage loans. Most pass-through mortgage securities are issued and/or guaranteed by GNMA, FNMA or FHLMC and carry an implied AAA credit rating. The payments of principal and interest on pass-throughs are considered secure; however, the cash flow on these investments may vary from month to month, depending on the actual prepayment rate of the underlying mortgage loans. Most pass-throughs are backed by fixed-rate mortgage loans; however, adjustable-rate mortgage loans (ARMs) are also pooled to create the securities. Most ARMs have caps and floors limiting the extent of interest rate changes.

PO (Principal Only) – Represents the right to receive 100% of the principal payment and zero of the interest payment on the mortgages.

Prime Rate – The indicative interest rate on loans that banks quote to their best commercial customers.

Repurchase Market – A market in which an institutional investor finances their securities purchases. The investor sells (pledges) their securities to a broker-dealer for a loan, with the agreement that the investor will buy them back on a predetermined date at a specified price. The difference between the principal received and the amount paid to the broker-dealer represents the interest on the loan. The term of each transaction can be as short as one day or as long as five years. The interest rate is highly correlated to the Fed Funds rate.

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