What is a Cash CDO? 

The first incarnations of CDOs were CBOs (collateralized bond obligations) of high yield bonds and CLOs (collateralised loan obligations) of leveraged loans.  The concept of these structures was then extended to many more asset classes, including investment grade bonds, asset backed securities, real estate investment trusts (REITs), hedge fund units, private equity shares, trust preferred bonds, derivatives (such as credit default swaps), equity (through shares, equity default swaps, and/or options) and commodities.

CDOs can be categorised by their various different attributes in many different ways, some of which are listed below:

  • cash, synthetic, or hybrid assets

  • managed or static

  • full capital structures or single tranche technology

  • cash-flow (asset-liability matched) or market value

  • asset types

Another way to categorise CDOs is by their primary function. CDO technology may be used to achieve one or more of the following goals:

  • credit risk transfer

  • funding illiquid assets

  • leveraged return on credit assets

  • regulatory and/or economic capital relief

It should be remembered that a CDO, particularly a cash CDO, is not an asset class in its own right but a financing technique particularly suited to illiquid assets. It is therefore only as robust as the assets that are put into it.  It is like a “mini-bank”: it raises capital by selling debt and “equity”, and invests the money raised into assets to generate an “excess” return. Cash CDOs are often called “arbitrage” CDOs because the assets are worth more repackaged than as individual securities.