CMO vs Mortgage Pass through securities

CFA Level II
#1

Hi guys

It is clear to me that Collateralized Mortgage obligations are backed by Mortgage Pass through security and that Mortgae pass through securities are backed by loans/mortgages etc.

I have read that the reason to create CMO is tranching, hence the ability to investors to be exposed to different type of credit/prepayment/extension risk.

My question is why a 3 layers structure is needed?

Couldn’t just the Mortgage Pass through security be structured on different tranches that would have different priorities of payments? Am I missing something here?

Thanks a lot!

#2

A pass-through security is a pool of mortgages all having simillar credit qualities and cash flows.

A CMO is a pool of pass-through securities that allocates cashflow prepayment and interest based on it’s own structure. So an investor doesn’t need to worry about choosing the type of mortgage that would give him a certain type of credit exposure. The CMO handles it for him. Same goes for CDOs.