This feature gives IO's some of the characteristics of hedging instruments with negative duration. Tranche is French word for slice. While other tranches are outstanding, the Z-tranche receives credit for the periodic interest payments that increase in face value but are not paid out. When other tranches are retired, the Z-tranche begins to receive cash payments that include both principal and continuing interest. Here are some more definitions on certain CMO's- collateralized mortgage obligations with supposed advantages and disadvantages.
Average lives are about two to ten years.
Stable total return, price stability Disadvantage-Lack cash flow stability as interest rates fluctuate. These are structured to offset floating rate tranches. Because IF''s are more leveraged than other tranches, they have high price volatility as interest rates move. Moderate interest rate changes can cause large changes in price and totally return Interest Only - these tranches only receive the interest portion of the cash flow. Since IO tranches have little or no principal, prepayments wipe out future cash flows.