Collateralized debt obligation

(1) Ownership of the receivables to be securitized is usually transferred to a special purpose entity, which issues several tranches of securities that represent the interests in the pool of debt. Eventually, the principal and interest flows from the underlying collateral are distributed among various tranches and paid through to security holders. By reallocating the cash flows this way, the tranches of securities can be structured on the basis of different maturities. By organizing tranches of securities in a subordinated structure, each tranche will be used in an assigned order to absorb losses in the event of default on receivables in the pool. Such a structure might include, for example, senior (rated AAA) securities, mezzanine (rated A) securities, junior (rated BBB to B) securities, and residual (unrated) securities. The specific tranche structure can be adapted to investor requirements for different degrees of credit risk. (2) Collateralized debt obligations differ from asset-backed securities in that the underlying receivables are more diversified. (3) Collateralized debt obligations include collateralized bond obligations (CBO) and collateralized loan obligations (CLO), which in turn include collateralized mortgage obligations (CMO).