Collateralised debt obligation (CDO) is one of the most unhelpful pieces of terminology in the financial markets. The term can be misleading for several reasons. First, not all CDOs are collateralised. Second, the term is most often used to refer to a transaction and not to the individual securities that are issued in that transaction (which are usually called CDO securities, notes, classes, tranches or liabilities). CDO is also used to refer to a range of financial instruments which are quite different from each other in terms of construction.
CDOs are, however, a crucially important part of the financial market, since they channel investment into credit and, in return, give investors highly customised exposures to credit risk. In essence, they are a means of transforming a portfolio of assets (bonds, loans, credit default swaps, asset-backed securities and so on) into different investments (tranches), each with a different risk-and-return profile.
The first CDOs were known as collateralised bond obligations (CBOs) by analogy with the collateralised mortgage obligations (CMOs) used in the US mortgage-backed market. These CDOs, which appeared following the growth of the high yield bond market in the late 1980s, used high yield corporate bonds in the underlying portfolio.
Cash CDOs
How a cash CDO works
Synthetic CDOs
Synthetic innovations
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