A secured debt obligation is an investment backed by multiple assets, including non-mortgage bonds or bank loans, creating higher risk but also higher returns. Collateralized debt obligations (CDOs) are investment grade securities that use a mixture of debt instruments to back a single bond. Investors do not own the debt instruments but have access to profits. CDOs can carry varying degrees of risk depending on the debt involved. The term CDO is sometimes used broadly to identify any type of secured obligation.
A secured debt obligation is any investment that is backed by a collection of several assets. Often, this collection of cover assets will include bonds or bank loans that are not classified as mortgages. This provision creates a higher degree of risk for the investor, as there is a possibility of default on loans supporting the investment. In return for assuming this higher risk, the investor has the ability to realize a higher rate of return on the investment.
The collateralized debt obligation, or CDO, is considered an investment grade security. With this type of security, there is some type of debt or equity present. Equity debt is supported by a stable organization which is considered to be solvent and reputable. An investor is willing to assume the higher risk associated with debt or equity in anticipation of receiving compensation when the debt is repaid.
CDOs typically do not use a single type of debt to back the obligation. Instead, a mixture is usually involved, with several debt instruments used to back a single bond. In effect, when an investor makes a purchase in a covered debt obligation, he is buying an interest in multiple debt instruments at the same time. The cumulative amount of risk it entails depends on the amount of individual risk associated with each instrument used in the transaction.
It is important to note that a secured debt obligation does not actually transfer ownership of the debt instruments to the investor. However, the business allows the investor access to any profit made from the instruments involved. For investors who don’t want to buy and service debt directly, using a secured debt bond is a great option.
Typically, the debt used to support the secured debt obligation is mixed. That is, various debts will have different maturity dates and carry different degrees of risk. The amount of interest paid on each of the debts depends on how much risk is associated with each debt included in the bond. Because of this type of debt mixing, it is possible for an investor to find some examples of CDOs that carry less risk than others.
Although a collateralized debt obligation is generally defined as an investment secured by a group of different debts, the term is sometimes used more broadly. In some circles, a collateralized debt obligation is used as a general term to identify any type of secured obligation, including loans, mortgages, or bonds.
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