Meaning
A collateralized debt obligation is a kind of financial pool that brings together all the available debt instruments, such as loans, mortgages and bonds, compiles them and ranks them according to their risks and returns. Later, the investors can delve upon these tranches and purchase them as per their profit analysis. They also gain marginable income from the underlying debts and repayments.
HOW DOES IT WORK?
Collateralized debt obligations work on the principle of categorization into mainly 3 ranks according to their risks and returns:-
- Senior
- Mezzanine
- Equity
Senior tranches are the first tranches to receive payment from their underlying debts followed by mezzanine and equity. These provides investors to analysis their expansion of profits and choose wisely according to level of risk, higher risk level providing a big margin of profit.
BENEFITS
- One of the most significant advantage of CDO is high value return rates even when invested in low-returns or high risk potential trenches.
- Is versatile in terms of meeting specific risk and returns preference of investors and strategies.
- By investing in CDOs, investors can spread their risk across a variety of issuers and asset classes, and gain exposure to a portfolio that is diversified in debt instruments.
