Consider the following scenario:

As a manager of a savings institution, you must decide whether to invest in collateralized mortgage obligations (CMOs). You can purchase interest-only (IO) or principal-only (PO) classes. You anticipate that economic conditions will weaken in the future and that government spending and demand for funds will decrease.

Based on this scenario answer the following questions.

• Given your expectations, would IOs or POs be the better investment? Explain and support your answer.
• Given the situation, is there any reason why you might not purchase the class of CMOs that you selected in your previous answer?