Collateralized Debt Obligations (CDO) were first issued in 1987 to allow investors the opportunity to invest in the underlying collateral indirectly. The underlying collateral assets and securities are typically comprised of various loans or debt instruments and financed by issuing multiple classes of debt and equity. CDOs either have a static structure or an active structure that is managed by a portfolio manager. With a static deal, investors can assess the various tranches within the CDO. With an active deal, a portfolio manager will actively manage the CDO by reinvesting the cash flow by buying and selling the assets. Portfolio managers perform coverage tests for the protection to the note holders and an event of default may be triggered if collateral values fall too low.
CLO, also known as Collateralized Loan Obligation, is a special purpose vehicle (SPV) with securitization payments in the form of different tranches. Financial institutions back this security with receivables from loan portfolios. CLOs allow banks to reduce regulatory capital requirements by selling large portions of their commercial loan portfolios to international markets, reducing the risks associated with lending.
CDOs and CLOs are similar in structure to a Collateralized Mortgage Obligation (CMO) or Collateralized Bond Obligation (CBO).