Collateralized bond obligation (CBO)

A collateralized bond obligation or CBO is a type of structured debt security. They are defined to be investment-grade bonds that are backed up by high-risk junk bonds.

Even though the junk bonds are high risk in nature and typically not considered investment-grade, they serve as security: The pooling of several types of quality credit bonds offers enough diversification to count them as investment-grade, in this instance.

Collateralized bond obligations come with a fairly good interest rate, but since they are considered to be lower risk than the individual junk bonds that are backing them, interest rates are not the highest in the market.

Even then CBOs are attractive to investors, especially if the investor is more particular about the diversity of his investment, compared to the high yield of an investment. The modest interest still does turn off investors that are looking for a huge profit. To be able to sell CBOs, brokers emphasize the reduced risk, as well as excellent potential, associated with this type of investment.

Usually the kind of junk bonds that are offered as part of a collateralized bond obligation are corporate bonds. As mentioned earlier, the pooling of junk bonds to form a CBO is very particular about credit quality. Since corporate bonds have a good range of credit quality pooling them together makes for an investment portfolio with an overall relatively good credit quality.

CBOs are also similar in structure to a collateralized mortgage obligation (CMO), but significantly differ in the levels of credit risk.

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