Collateralized Debt Obligation [CDO]

A Collateralized Debt Obligation (CDO) is a complex structured finance product that pools together cash flow-generating assets and repackages them into discrete tranches that can be sold to investors. CDOs can include bonds, mortgages, loans, and even other CDOs (called CDO-squared). Each tranche has different risk levels and returns: senior tranches are paid first and have lowest risk, while equity tranches are paid last and carry highest risk. For example, a CDO might contain $100 million of corporate bonds, mortgage-backed securities, and loans, divided into tranches rated from AAA to unrated equity. During the 2008 crisis, CDOs containing subprime mortgages lost massive value when housing prices fell and defaults soared. Synthetic CDOs, which use credit default swaps instead of actual bonds, amplified the crisis. Warren Buffett famously called CDOs ‘financial weapons of mass destruction.’