Collateralized Debt Obligation (CDO)
A collateralized debt obligation (CDO) is a type of financial instrument in which multiple debt obligations are packaged together and sold to investors. CDOs are typically structured as bonds, but can also be structured as notes or other types of securities. They are often used to raise money for companies, governments, and other organizations by enabling them to borrow from capital markets without having to issue new shares or bonds directly.
CDOs generally involve the pooling of different types of debt instruments such as mortgages, auto loans, credit card receivables and corporate loans among others. The individual debts that make up the CDO offer varying levels of risk; since some may default while others remain current on their payments. To mitigate this risk, a portion of these assets—known as “collateral”—are pledged to secure repayment if one or more defaults occur within the portfolio. This collateral includes both cash reserves and additional high-quality investments such as government bonds or treasury bills that can be liquidated in order to cover any losses incurred due to defaulted debts in the portfolio.
The structure of a CDO allows for diversification benefits not available with traditional investment products; it enables investors access into a large pool with many different kinds of borrowers across various sectors rather than being limited solely to those entities which have issued direct public offerings through equity markets . Furthermore, because there is built-in protection from defaults due to collateralization , they can offer higher yields than similarly rated corporate bond issues when market conditions permit .
In addition to providing returns for investors , CDOs allow businesses seeking financing quicker access at lower cost compared with issuing separate deals through typical underwriting processes ; consequently , they have become increasingly popular over recent years .
