Definition of Collateralized Debt Obligation (CDO)

diversified, multiclass security similar to a Collateralized Mortgage Obligation (CMO) and backed by pools of bonds, bank loans, or other assets. ACDO may own corporate bonds, commercial loans, asset-backed securities, residential mortgage-backed securities, commercial mortgage-backed securities, and emerging market debt. These securities are typically divided into several classes, or bond tranches, that have differing levels of credit tolerances and typically contain at least one class of investment-grade bonds. Most CDO issues are structured in a way that enables the senior bond classes and mezzanine classes to receive investment-grade credit ratings; credit risk is shifted to the most junior class of securities. If any defaults occur in the assets backing a CDO, the senior bond classes are first in line to receive principal and interest payments, followed by the mezzanine classes and finally by the lowest rated (or nonrated) class, which is known as the equity tranche. The CDO market is one of the fastest growing sectors in the bond market worldwide, largely owing to the wide latitude given sponsoring organizations; a CDO bond issue can own almost any type of marketable assets, even holdings in other CDOs. CDO may also refer to the investment vehicle-known formally as a Special-Purpose Vehicle (SPV)created to hold assets backing a CDO investment portfolio.