What is a collateralized debt obligation (CDO)?

A collateralized debt obligation (CDO) is a structured financial product that pools together various types of debt, such as loans and bonds, and then slices this pool into different tranches to be sold to investors. The cash flows from the underlying assets are used to pay off these tranches in a specific order based on their risk levels.

The structure of a CDO allows for the pooling of diverse credit exposures, which can include mortgages, corporate bonds, and other forms of debt, thereby providing investors with a way to gain exposure to different credit markets through a single instrument. By transferring the credit risk associated with these debts to the CDO investors, issuers can manage their own risk while providing a structured investment product that can potentially offer attractive returns in varied market conditions.

In contrast, other options either mischaracterize CDOs or do not align with their fundamental nature. For instance, referring to a CDO as a corporate bond overlooks the structured and secured nature of the instrument and its backing by a diversified pool of debts. Identifying it as devoid of risk is misleading as all financial instruments come with inherent risks, especially CDOs, which can be prone to credit and market risks. Lastly, describing it as an unsecured loan to businesses