Collateralized debt obligations

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Top Contributors Tom Shohfi Avinash Patil

A key part of the subprime crisis due to which the US is on the verge of recession.

It is an investment-grade security backed by a pool of bonds, loans and other assets. CDOs do not specialize in one type of debt but are often non-mortgage loans or bonds.

It is similar in structure to a collateralized mortgage obligation (CMO) or collateralized bond obligation (CBO), CDOs are unique in that they represent different types of debt and credit risk. In the case of CDOs, these different types of debt are often referred to as 'tranches' or 'slices'. Each slice has a different maturity and risk associated with it. The higher the risk, the more the CDO pays.

[edit] Synthetic CDOs

The term synthetic applies to a CDO where the underlying assets are credit default swaps (CDS) rather than the debt instruments themselves. For example, assume that we wanted to construct a $100 million CDO instrument from ten equal sized parts of low correlation corporate debt. The bonds themselves may be illiquid or otherwise costly to obtain, but selling CDS protection may be much more cost effective.

[edit] CDO^2

CDO Squared, Cubed, etc refers to a CDO that is constructed from separate CDO tranches, typically with low correlation, that are repackaged into a new CDO instrument. Essentially, this is a CDO of CDOs. This difficulty in valuing and correctly predicting correlation between the underlying assets of these instruments has been apparent throughout the credit crisis and has severely effected financial instutitions, including MBIA. ^[1]

For an illustrated explanation, visit Anatomy of a CDO at the Wall Street Journal

1. ↑ MBIA slumps on concern about CDO exposures, Marketwatch.com.