Definition: Collateralized debt obligations

Category: External debt - IMF

Collateralized debt obligations (CDOs) are bonds whose income payments and principal repayments are dependent on a pool of instruments. Typically, a CDO is backed by a diversified pool of loan and bond instruments either purchased in the secondary market or from the balance sheet of a commercial bank. The diversified nature of the instruments differentiates a CDO from an asset-backed security, which is backed by a homogeneous pool of instruments, such as mortgages and credit card loans. Because income and the repayment of principal are dependent on the performance of the underlying instruments, there is a probability of early repayment. Issuers are often provided with different tranches of the security, so that if there are prepayments the first tier will be repaid first, the second tier next, etc. The pricing of each tranche reflects the probability of repayment. http://ec.europa.eu/eurostat/ramon/statmanuals/files/external_debt_guide_2003_EN.pdf#page=227