CMO-Inverse Interest Only (Inverse IO)

A reader asked if I had an example of a CMO Inverse IO, and I did not. Although I have not had access to a Bloomberg to check my assumption, I thought I would give it a try. Actual IO’s may vary from my example, but I think I have captured the essences of an IO CMO.  The assumptions I used are as follows:

  1. My example is made up of two tranches, a Floater and an Inverse IO.
  2. The Floater retains all the principal payments.
  3. The Floater rate equals 1 month LIBOR, plus the margin.
  4. The IO rate equals the APR collateral rate, minus the Floater margin and minus 1 month LIBOR
  5. Assumptions 3 and 4 guarantee the sum of both tranches rates are equal to the collateral rate.
  6. The IO rate =MAX(0, IO Index-LIBOR)
  7. The Floater rate =MIN(Collateral Rate, LIBOR + Floater Margin)
  8. A LIBOR based interest payment is based on an actual/360 basis. For simplicity, interest for this example is assumed to be paid the same as the underlying MBS, 30/360.
  9. Only the yellow cells are variables.

Download “CMO-InverseIO”

Don Pistulka
Don Pistulka

Retired Credit Union CFO - Finance
Background: over 40 years in investments, asset/Liability management, banking, securities trader.
Worked for: California Credit Union, WesCorp, CalFed S&L, Crocker Bank, Carroll McEntee, Federal Home Loan Bank Board (D.C.), Western Asset Management, Security Pacific National Bank.

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