What Is a Collateralized Debt Obligation Squared (CDO-Squared)?

A collateralized debt obligation squared (CDO-squared) is an investment in the form of a special purpose vehicle (SPV) with securitization payments backed by collateralized debt obligation tranches. A collateralized debt obligation is a product structured by a bank in which an investor buys a share of a pool of bonds, loans, asset-backed securities, and other credit instruments. Payments resulting from those bonds, loans, asset-backed securities, and other instruments are then passed on to the holders of the shares of the collateralized debt obligation. It is a way to invest in multiple credit instruments and diversify risk.

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A Primer On Collateralized Debt Obligation (CDOs)

Understanding Collateralized Debt Obligation Squared (CDO-Squared)

A collateralized debt obligation squared (CDO-squared) is another product structured by a bank. The bank takes their collateralized debt obligations and structures them into tranches with different maturity and risk profiles. These tranches then fund the payments to the investors in the CDO-squared special purpose vehicle. The collateralized debt obligation squared is backed by the pool of collateralized debt obligation (CDO) tranches and payments to investors are made from payments made into the various tranches.

The collateralized debt obligation squared is similar to a collateralized debt obligation except for the assets securing the obligation. Unlike the collateralized debt obligation, which is backed by a pool of bonds, loans, and other credit instruments; collateralized debt obligation squared arrangements are backed by collateralized debt obligation tranches. Collateralized debt obligation squared investments allow the banks who own the regular collateralized debt obligations to resell the credit risk they have taken on.

Since consumers stopped making financing payments for many of the assets backing the collateralized debt obligations and therefore the collateralized debt obligations squared, the CDO and CDO-squared market collapsed during the 2008 global financial crisis.