Level 1 CFA® Exam:
Collateralized Debt Obligation (CDO)

Last updated: January 04, 2023

CDO Basics for Level 1 CFA Candidates

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Collateralized debt obligation (CDO) is a security backed by a diversified pool of debt obligations.

CDOs are actively managed by collateral managers who buy and sell debt obligations for and from the CDO’s collateral.

Typical CDO structure consists of:

  • senior bond classes,
  • mezzanine bond classes, and
  • residual (equity) tranches.

The riskiest are equity tranches and the least risky are senior bond classes. However, the potential return is the highest for equity tranches.

The ultimate goal of a collateral manager is to buy debt obligations (the collateral) using the money from the issuance of bond classes and then generate a return exceeding the cost.

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Level 1 CFA Exam Takeaways: Collateralized Debt Obligation (CDO)

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  1. Collateralized debt obligation (CDO) is a security backed by a diversified pool of debt obligations.
  2. CDOs are actively managed by collateral managers.
  3. Typical CDO structure consists of: (1) senior bond classes, (2) mezzanine bond classes, and (3) residual (equity) tranches.
  4. The sources of return for CDO are: (1) interest, (2) proceeds from selling the debt obligation from the collateral, and (3) principal repayments and prepayments.
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