Collateralized Debt Obligation

A Collateralized Debt Obligation (CDO) is a complex financial instrument that pools various types of debt, such as mortgages, Bonds, and other loans, and then issues tranches of Securities backed by these Assets. The Cash Flows generated by the underlying debt are used to pay investors in the different tranches, which carry varying degrees of risk and return.

CDOs are typically divided into senior, mezzanine, and Equity tranches:

• Senior Tranche: Has the lowest risk and receives payment first, typically rated AAA.
• Mezzanine Tranche: Carries more risk and offers higher Returns, usually rated between BBB and BB.
• Equity Tranche: The highest risk with the potential for the highest Returns, often unrated.

Examples of CDOs include:

• Mortgage-Backed Securities (MBS): CDOs that are backed by a pool of mortgage loans.
• Asset-Backed Securities (ABS): CDOs that may include auto loans, Credit card debt, or student loans.

Cases of CDOs:

• The 2007-2008 financial crisis highlighted the risks of CDOs, particularly those backed by subprime mortgages, which led to significant losses for investors.
• In 2020, the market for CDOs saw a resurgence as investors sought higher yields amid low Interest Rates.