Define: Collateralized Debt Obligations

UK Accounting Glossary

Definition: Collateralized Debt Obligations



What is the dictionary definition of Collateralized Debt Obligations?

Dictionary Definition


A Collateralized Debt Obligation or CDO is investment-grade security endorsed by a pool of loans, bonds and other assets. The structure of a CDO can be constructed of debt of any type-except mortgages. A collateralized debt obligation is generally cut up into slices, each slice of debt carrying a unique amount of risk associated with it. Each slice (also known as tranch) has a maturity period dissimilar to its peers in the same CDO. The greater the risk in a slice, the more paying potential of CDO.

CDOs are usually purchased by investors who want the associated benefits rendered by the specific debt but do not wish to buy the debt themselves.


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Full Definition of Collateralized Debt Obligations


Collateralized debt obligations (CDO) are a form of asset-backed security (ABS). Collateralized debt obligations are complex structured investment products that are collateralized by a group of assets (i.e. bonds, business loans, other collateralized debt obligations, etc.). The idea behind collateralized debt obligations is that you can create an investment-grade financial product and create liquidity by pooling assets together. Collateralized debt obligations pool assets which would be more illiquid and/or riskier on their own and therefore not as tradable. Collateralized debt obligations are sold in various tranches. Each tranche of a collateralized debt obligation offers a different risk level and depending on the type of collateralized debt obligations, a different maturity as well. Tranches of collateralized debt obligations with higher credit risk tend to be sold at higher prices than tranches with lower default risk. Once collateralized debt obligations are sold, the underwriter has no further responsibility in collecting on the debt. As a result, should a default occur, it becomes the responsibility of the holder of the collateralized debt obligations to collect. Misaligned interests between investors and underwriters of collateralized debt obligations can lead to lower standards when selecting eligible assets to be included within collateralized debt obligations. Collateralized debt obligations only including bonds are called collateralized bond obligations (CBO). Collateralized debt obligations only including commercial loans are called collateralized loan obligations (CLO). They are both types of collateralized debt obligations. Although collateralized debt obligations include bank loans, collateralized debt obligations do not typically include mortgages. Mortgages are pooled in asset-backed securities called collateralized mortgage obligations (CMO).

Synthetic CDO

It is a kind of collateralized debt obligation or CDO that is endorsed by credit derivatives. The list of credit derivatives may include forward contracts and options.

Collateralized Bond Obligation (CBO)

A Collateralized Bond Obligation or CBO is an investment-grade bond endorsed by a pool of junk bonds or high yield bonds. A CBO is considered investment grade for the presence of credit quality bonds despite junk bonds, not investment grade.

Collateralized Mortgage Obligation (CMO)

It is a variation of mortgage endorsed security that makes different pass-through rate pools with dissimilar maturities called tranches. Repayments from these tranches are employed to retire bonds in accordance with that bonds’ prospectus. CMOs are associated with low risk and thus offer lower returns. Some CMOs are endorsed by government securities.

Asset-Backed Commercial Paper

Asset-backed commercial paper is a type of investment that is characterized by short maturity times. The maturity time is generally between 90 and 180 days. The commercial paper is endorsed by tangible assets, including trade receivables. Asset-backed commercial paper is usually employed to meet financial needs in the short term.


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Synonyms For Collateralized Debt Obligations


CDO


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Definition Sources


Definitions for Collateralized Debt Obligations are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 4th February 2020.