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Derivatives

  Derivatives   |   Terms
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  • September 2, 2021
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Interest Only

The interest-only portion of a mortgage loan. Financial institutions, especially mortgage financing firms, separate a series of interest payment from a mortgage loan and issue securities backed by the interest-only portion (known as IOs). In other words, some mortgage pass-throughs can be decomposed into mortgage strips, each consisting of an interest or principal stream, which are interest-only (IO) and principal-only (PO) sold separately. Investors can purchase either or both strips.

An owner of IOs bets that interest rates will go up, whilst the issuer predicts a downward movement in rates.

IOs are classified as a type of interest rate derivatives, as they derive their value from interest payment on a pool of assets.


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