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What are Collateralized Debt Obligations (CDOs)?

What are Collateralized Debt Obligations (CDOs)?

Collateralized Debt Obligations (CDOs) are bond-like investments backed by debts such as mortgages. The mortgages or debt obligations are pooled together and divided into tranches based on the maturity date and coupon payments and sold as securities (CDOs).

If interest rates change and the borrowers in the underlying pools can refinance their debts, the CDOs will experience some volatility as the obligations are paid off early, but how much volatility depends on which tranche the investment is in.

Senior tranches have lower risk and lower payouts, but higher credit ratings than junior tranches. Collateralized Mortgage Obligations (CMOs) are a type of CDO and are based on pools of GNMA (Ginnie Mae), FNMA (Fannie Mae), and FHLMC (Freddie Mac).

CDOs were at the center of the financial crisis of 2007-2009, as some of the largest financial institutions lost billions of dollars in CDO investments in a short amount of time.

Keywords: volatility, bond, interest rate, mortgages, refinancing, Collateralized Debt Obligation (CDO),