Which describes the cash-flow sequencing of CMOs?

• A. Payments are directed to the oldest maturity first
• B. Payments are directed to the newest maturity first
• C. Payments are distributed evenly across all tranches
• D. There is no predetermined sequencing

Answer: (B)

In CMOs, cash flows follow a fixed waterfall. The mortgage payments are allocated to the tranches in a pre-set order, so who gets paid isn’t random but determined by the deal’s structure. In the common sequencing described, payments are directed to the newest maturity tranche first, meaning the most recently issued (shortest remaining life) class is retired before older ones. This creates a predictable pattern of principals being paid down and helps define the risk and timing for each tranche.

Paying the oldest maturity first would reverse that built-in flow and isn’t how the standard CMO waterfall operates. Distributing evenly across all tranches would defeat the purpose of the tranche structure, which is to create distinct cash-flow priorities. And since there is a predetermined sequencing in CMOs, saying there’s no predetermined order isn’t accurate.