General Securities Representative (Series 7) Practice Exam

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Prepare for the Series 7 Exam for General Securities Representatives. Study with comprehensive multiple-choice questions, each with detailed explanations to ensure you understand key concepts. Excel in your exam with confidence!

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When is the principal paid in a collateralized mortgage obligation (CMO)?

At maturity of the tranche
At the discretion of the issuer
Over the expected life of the tranche
Upon a change in interest rates

The correct answer is: Over the expected life of the tranche

In a collateralized mortgage obligation (CMO), the principal is paid over the expected life of the tranche. This payment structure is essential to understand because CMOs are designed to distribute cash flows from mortgage payments among different tranches based on their specific characteristics and risk profiles. Each tranche might have different maturity dates, interest rates, and payment priorities. As homeowners make mortgage payments, these payments are pooled together and then delivered to the various tranches according to the CMO's structure, which is predetermined. Tranches with shorter maturities or lower priority in payment may receive principal payments sooner, while longer-maturity tranches will receive their principal over a more extended period. This payment mechanism aims to provide a steady stream of income to investors and allows for various risk tolerance levels among different investors in the CMO. Understanding this process is crucial for defining the investment characteristics of CMOs, as it impacts cash flow, the risk and return profile, and how investors manage duration and interest rate risk within their portfolios.