Companion bonds

Companion bonds

A class of a Collateralized Mortgage Obligation (CMO) whose principal is paid off first when the underlying mortgages are prepaid due to falling interest rates. When interest rates rise, there will be lower prepayments of the principal; companion bonds therefore absorb most of the prepayment risk of a CMO.
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Companion bonds, which receive payments only after the PAC schedule is met, are particularly risky.
The companion bonds are mostly floater/ inverse floater pairs, with a support PAC, and a support TAC.
Disadvantages: lower yield, protection varies with characteristics of companion bond.

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