What Is a Collateralized Debt Obligation (CDO)?
A collateralized debt obligation (CDO) is a multifaceted structured finance creation that is backed by a pool of loans and other possessions and sold to institutional savers. A CDO is a particular type of derivative because, as its name implies, its value is resultant from another original asset. These assets become the security if the loan defaults.
Types of CDOs
These tranches of securities become the concluding investment products: bonds, whose names can reflect their specific underlying assets. For example, mortgage-backed securities (MBS) are included of mortgage loans, and asset-backed securities (ABS) contain corporate debt, auto loans, or credit card obligation. CDOs are called “collateralized” because the promised refunds of the underlying assets are the collateral that gives the CDOs their value. Other types of CDOs include collateralized bond obligations (CBOs)—investment-score bonds that are backed by a pool of high-yield but lower-rated bonds, and collateralized loan obligations (CLOs)—single securities that are backed by a pool of debt, that sometimes comprise company loans with a low credit rating.