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4) Leverage is a way to increase the buying or investing possibilities for investment firms. Explain...

4) Leverage is a way to increase the buying or investing possibilities for investment firms. Explain how leverage worked in the CMO market and the positive or negative affect it had on the housing market.

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Q 4)

The leverage is the life blood for most of the investment firms. The Collateralized mortgage obligation (CMO) is a mortgage backed security that contains combination of mortgages that are sold as an investment. CMOs consist of different tranches that have different principal amounts, Interest payments, maturity dates and are ranked as per the risk profile. The CMOs are vulnerable to interest rate changes and economic cycles.

CMOs played a prominent role in the housing market bubble burst in 2008 financial crisis. During the 2008 financial crisis the hedge funds and banks created different mortgage backed securities mainly CMOs. The spike in the housing market led the insurance companies to insure them with Credit default swaps.

When the Fed started raising rates the demand for mortgage increased and increased the required mortgage payments which the borrowers couldn't repay and the housing prices fell which led to a situation that the house owners couldn't sell homes leading to defaults on CMOs.

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