An tranche of a collateralized mortgage obligation (CMO) that accrues by adding the interest amount to the face value of the bond. This tranche is usually one of the last segments to be paid off in cash. The term Z-bond is originally borrowed from zeros or zero-coupon bonds which are typically traded in the government strip market. However, and technically, it is an inappropriate designation due to the fact that a coupon that is attached to the bonds is only paid to the holder in cash as soon as the lookout period expires, i.e., where the bonds begin making principal payments.
In other words, a Z-bond only pays interest after the lookout period expires, but the interest amounts are deferred and added to the bond’s principal value, in a process that is usually called “accretion“. These interest amounts will be directed to another bond in the structure, whether to build up the principal for a totally different tranche or to be combined with an existing one.
Z-bonds are also called Z-tranches or accrual bonds.
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