Collateralized debt obligations

Source: Wikipedia

Collateralized debt obligations (CDOs) are a type of asset-backed security and structured credit product.

CDOs gain exposure to the credit of a portfolio of fixed income assets and divide the credit risk among different tranches: senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches (unrated).

Losses are applied in reverse order of seniority and so junior tranches offer higher coupons to compensate for the added risk. CDOs serve as an important funding vehicle for portfolio investments in credit-risky fixed income assets.

Market history and growth
First issued in the late 1980s, CDOs emerged a decade later as the fastest growing sector of the asset-backed securities market.

This growth reflects the increasing appeal of CDOs for a growing number of asset managers and investors, which now include insurance companies, mutual fund companies, unit trusts, investment trusts, commercial banks, investment banks, pension fund managers, private banking organizations, other CDOs and structured investment vehicles.

According to the Securities Industry and Financial Markets Association, aggregate global CDO issuance totalled USD $157 billion in 2004, USD $249 billion in 2005, and USD $489 billion in 2006.