Introduction to Structured Finance

CHAPTER 6

Cash Flow Collateralized Debt Obligations

The collateralized debt obligation (CDO) was a natural advancement of securitization technology, first introduced in 1988. A CDO is essentially a structured finance product in which a distinct legal entity, a special purpose vehicle (SPV), issues bonds or notes against an investment in cash flows of an underlying pool of assets. These assets include one or more of the following types of debt obligations:

• investment-grade and high-yield corporate bonds;
• emerging market bonds;
• residential mortgage-backed securities (RMBS);
• commercial mortgage-backed securities (CMBS);
• asset-backed securities (ABS);
• real estate investment trusts (REIT) debt;
• bank loans;
• special-situation loans and distressed debt; and
• other CDOs.

When the underlying pool of debt obligations consists of bond-type instruments, a CDO is referred to as a collateralized bond obligation (CBO). These CDOs are classified as corporate bond-backed CDOs, emerging market-backed CDOs, and structured finance-backed CDOs. The collateral for the latter includes RMBS, CMBS, ABS, and REIT debt. When the underlying pool of debt obligations is bank loans, a CDO is referred to as a collateralized loan obligation (CLO).

Originally CDOs were developed as repackaging structures for high-yield corporate bonds and illiquid instruments such as certain convertible bonds, but they have developed into sophisticated investment management vehicles in their own right. Through the 1990s, CDOs were ...