Collateralised debt obligation (CDO)

A collateralised debt obligation (CDO) is a type of financial product – a credit derivative – which is backed by an underlying pool of loans.

A collateralised debt obligation (CDO) is a type of financial product – a credit derivative – which is backed by an underlying pool of loans. An investment bank pulls together mortgages, bonds, car loans, or any other type of debt, bundles them all up, then repackages them to sell to investors.

You can think of this process – securitisation – as like baking a cake. The different loans form the ingredients of the cake. The cake is then sliced into “tranches”. The riskiest tranches (those with the lowest credit rating) are last in the queue to get paid, while the least-risky tranches – the senior tranches – are first. So if any of the loans default, the riskiest tranches will suffer losses first. This is reflected in the higher yields on offer on the latter.

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