Collateralised debt obligations
Buying risky debt
Collateralised debt obligations (CDOs) are complex investments
that repackage a bundle of individual loans into a product that can
be sold. In exchange for interest payments, the buyer of a CDO
takes on the risk that the initial loans will not be repaid.
These are the products that triggered the global financial
What's in these
A CDO is a security based on a variety of
debts, such as mortgages or bonds, that can range from
secure to highly risky. These debts may also include car loans,
credit card debt or corporate debt. They are called collateralised
because they have some type of asset (collateral) behind
When you buy a CDO you are buying the right to receive interest
payments from a mix of loans and other debts. CDOs differ from
other fixed interest investments in that you are buying a bundle of
different debts with mixed creditworthiness.
What's the risk?
In return for higher interest payments, you bear the risk that
some of the loans or bonds in the pool will not be repaid. If this
happens, you will lose some or all of your original investment. The
riskier bonds and debts may provide higher returns, but there is
also a higher risk of losing earnings or capital.
CDOs are complex products. Even big institutions have lost
fortunes when trading them. We recommend you do not
invest in these products unless you have a written statement of advice from an independent,
licensed financial planner stating that the product is suitable for
One key risk is that you don't have direct information about the
individual borrowers behind each loan.
Here are some questions you should consider:
- How strict is the lending procedure?
- What is the underlying security really worth?
- Has the borrower's circumstances changed since the loan was
- Why is the original lender on-selling the loan(s)?
Each CDO is different. The calculations and
legal structures can be formidable and the offer documents can make
challenging reading. It's best to seek financial advice.
Last updated: 18 Dec 2015