Companion Bond

See: Collateralized Mortgage Obligation.

Just about everyone likes to have a good companion at times, and collateralized mortgage obligations (CMOs) are the same way. CMOs are a type of fixed income security (a bond that pays out interest) that uses mortgage-backed securities as collateral. Collateral is what is put up as a guarantee in case the issuer defaults. CMOs might issue a special class of bonds that will either increase the risk involved, which will have the potential for higher returns...or the bonds might decrease the risk, giving the investor more security. The investor gets to choose.

Now we’ll get to companion bonds. These are a type of CMO bond that is paid off first if the mortgages being used as collateral are prepaid. Prepayments often happen when interest rates go down (a lot of people refinance), so the companion bonds are taking on a lot of the prepayment risk in the CMO. Therefore, they're more volatile, and like any other type of investment, the riskier they are, the greater the potential is for higher yields.