Collateralised Debt Obligations (CDOs)

An investment-grade security backed by a pool of bonds, loans, and other assets structured so that there are several classes of bonds with varying maturities, called tranches. In structured finance transactions CDOs are backed by a relatively small pool of heterogeneous debt instruments. Securitized interests in the pool of assets are divided into tranches with differing repayment and interest earning streams. In the event of nonpayment or default, the higher-risk "equity" tranches absorb the first loss from anywhere in the portfolio, but up to a limit. After the equity tranche loss limit has been reached, the next least-secured tranche then suffers the additional principal loss, and so on. Interest earnings are typically redistributed toward the high-risk tranche from the more senior or secured tranches. Rating agencies provide separate ratings for each tranche.