Credit Derivatives: A Primer on Credit Risk, Modeling, and Instruments

6Collateralized Debt Obligations

The previous chapter looked at credit default swaps (CDSs), those written on one reference asset (single-name CDSs) and those written on several reference assets (multiname CDSs). The benefit of a multiname product such as a basket or portfolio default swap is that they allow investors to invest in a combined portfolio; individual credit risk is often difficult to assess, but in a pooled group of assets, the individual risk matters less.

For credit instruments backed by a pool of assets, one of the most popular derivatives in the market is the collateralized debt obligation (CDO). A CDO gathers reference assets such as loans, bonds, or other debt instruments and sells of pieces of the interests from the pool—or ...