A higher-risk CMO tranche could, for example, have an average life that changes from 2 years to 20 years with even a modest increase in interest rates. Higher risk refers here to the cash flow variability of the tranche, not its credit quality, although underwriters can create structured securities that combine higher average life sensitivity with lower credit quality. The highest yields go to those tranches that, by design, exhibit the most volatile average lives. Such tranches receive excess principal cash when prepayments rise, and pay off early. When prepayments are slower, these tranches may.
