What Is a Collateralized Debt Obligation Cubed?
Collateralized debt obligation cubed (CDO-cubed) is a derivative security backed by a collateralized debt obligation squared (CDO-squared) tranch. A CDO-cubed is a triple derivative, that is a derivative of a derivative of a derivative—which is why it has been called “derivatives on steroids."
A Primer On Collateralized Debt Obligation (CDOs)
A collateralized debt obligation cubed (CDO-cubed) is identical to a regular CDO, except for the assets securing the obligation. Unlike a CDO, which is backed by a pool of bonds, loans, and other credit instruments, CDO-cubeds are backed by CDO-squared tranches, which are derivatives backed by a pool of bonds, loans, asset-backed securities, and other credit instruments.
CDO-cubeds allow banks to resell the credit risk that they have taken once again, by repackaging their CDO-squareds. CDO-squareds and CDO-cubeds can be repackaged countless times to create derivatives that are quite different from the original underlying debt security. These are also referred to as CDO^n to show the unknown depth of some of these securities.
Unlike traditional derivatives, which are used to hedge risk or make leveraged bets, CDO-cubeds are an innovation that has spawned thousands of new investment assets, covering the entire spectrum of risk and return.