Interest Only (IO) Obligation

A tranche of a collateralized mortgage obligation or similar instrument whose owner receives only the interest or some part of the interest paid on mortgages in the underlying pool. IO tranches are not uniform. The value of a protected income-only stream usually increases if rates decline slowly and moderately, but the holder of a companion or support IO tranche may receive interest payments only until repayments reach a certain fraction of the face value of the pool. Rapid repayment of mortgage principal in a sharply lower rate environment reduces the total value of a pool's interest payments. If a specific IO tranche is designed to be affected first by prepayments, the interest payments available for that tranche can disappear quickly. The mortgage prepayment option and payments dependent on its exercise or nonexercise have proven to be difficult to predict and, consequently, to evaluate. See also Collateralized Mortgage Obligation (CMO), Companion Collateralized Mortgage Obligation, Mortgage-Backed Securities, Stripped Mortgage-Backed Security (SMBS), Planned Amortization Class (PAC) Bond, Prepayment Option, Principal Only (PO) Obligation, Tranche.

Glossary * I