tranche. Defaults are ignored because the agency that has issued the passthroughs used as collateral is expected to make up any deficiency. Thus, the credit risk of agency CMOs is minimal. However, the guarantee of a govern- ment sponsored enterprise does not carry the full faith and credit of the U.S. government. Fannie Mae and Freddie Mac CMOs created from Ginnie Mae passthroughs effectively carry the full faith and credit of the U.S. government.   Types of Bond Classes There have been a good number of products created in the CMO market that would be acceptable investments for short-term investors. But there are also a good number that short-term investors should avoid given the typical interest rate exposure a short-term investor seeks.   Sequential-Pay Tranches The first CMO was structured so that each tranche would be retired sequentially. Such structures are referred to as sequential-pay CMOs. To illustrate a sequential-pay CMO, we will use a hypothetical deal that we     will refer to as Deal 1. The collateral for Deal 1 is a hypothetical passthrough with a total par value of $400 million and the following characteristics: (1) the passthrough coupon rate is 7.5%, (2) the WAC is 8.125%, and (3) the WAM is 357 months. This is the same passthrough that we used in Exhibit 9.1 to describe the cash flows of a passthrough based on an assumed 165 PSA prepayment speed. From this $400 million of collateral, four tranches are created. Their characteristics are summarized in Exhibit 9.2. The total par value of the four tranches is equal to the par value of the collateral (i.e., the passthrough security). In this simple structure, the coupon rate is the same for each tranche and also the same as the collaterals coupon rate. There is no reason why this must be so, and, in fact, typically the coupon rate varies by tranche. Specifically, if the yield curve is upward-sloping, the coupon rates of the tranches will usually increase with average life. Now remember that a CMO is created by redistributing the cash flow-interest and principal-to the different tranches based on a set of payment rules. The payment rules at the bottom of Exhibit 9.2 set forth how the monthly cash flow from the passthrough (i.e., collateral) is to be distributed among the four tranches. There are separate rules for the pay- ment of the coupon interest and the payment of principal, the principal being the total of the regularly scheduled principal payment and any pre- payments.