After a mortgage backed security (MBS) is formed, it needs to be sold to the investor. To do that, the MBS needs to go through a securities dealer. This dealer is more than likely located on Wall Street along with MBS trading desks. To better cater to the investor, a securities dealer has to go through creative and innovative channels to make the MBS look attractive to an investor. There is many different structures a MBS can go through such as Collateralized Mortgage Obligation or a Collateralized Debt Obligation.
Collateralized Mortgage Obligation (CMO) are the typical bundle of mortgages that is sold as an investment that was first issued in 1983. They are categorized from maturity and level of risk, and as the repayments of the loan comes in as a cash flow they are distributed to the investors in the set guidelines of the investment. These investments, since of the differences of the mortgages included within type or risk, interest rates, and principal balances, they can be quite sensitive to the change in the housing economic conditions and interest rate changes. The CMO is structured with the capability to withstand a few defaults within but when a financial crisis hits and thousands within default is where the CMO cannot pay the investor and loses money.
A Collateralized Debt Obligation (CDO) on the other hand, incorporates not only mortgages within the security but other cash flow-generating assets such as other bonds and loans. Being first issued in 1984, it is similarly structured like a CMO, they have different levels of security based on the default risk of the investment and investors receive cash flows through the length of the CDO.
Securities Dealers carefully structure the CMO and CDO deals in order to make profit on the difference of price they bought the MBS and sold the MBS.