A collateralized bond obligation (CBO) is a bond backed by a pool of junk bonds, but is intended to be investment grade. The varying levels of credit quality of bond funding provide overall stability to the backstop, and the interest rates are usually credible. The risk is minimal, making it an attractive option for smaller investors.
A collateralized bond obligation is a bond intended to be investment grade. The bond obligation is secured by using a pool of junk bonds, which are generally not considered investment grade. However, the combination of multiple junk bonds representing different types of credit quality is often considered sufficient to give the covered bond the status of an investment grade bond.
In most cases, the junk bonds used to back a covered bond obligation will be corporate bonds. The varying levels of credit quality of bond funding help provide overall stability to the backstop, as there is a good chance that most if not all bonds will hold their value over the life of the bond issuance. Due to the diversity of hedging instruments, a covered bond bond may be an attractive option for an investor.
Commonly referred to as a CBO, the collateralized bond is usually issued with credible interest rates, although the rates are not always the best in the market. Part of determining the interest rate that is extended has to do with the exact composition of the junk securities that back the bond. If most bonds tend to exhibit healthy interest rates, the collateralized bond will reflect those circumstances.
As with any type of bond issue, a collateralised bond obligation carries certain elements of risk. However, it should be noted that the risk is quite minimal when viewed in light of the normally applicable interest rate. A collateralized bond is not an investment that is likely to attract investors looking to make a huge profit from the venture, but smaller investors often find this type of bond with its modest yield worth considering. Bond brokers are often able to direct clients to bonds of this type that offer excellent potential.
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