Collateralised debt obligation

A synthetic creation at the heart of the sub-prime crisis. It is an instrument backed by a pool of bonds and other debt obligations, usually from a variety of issuers. The repackaged debt is reissued as separate tranches, each with its own credit rating, from AAA downwards. The final, riskiest tranche, known as the equity portion, pays the highest yield but takes the loss if any of the underlying bonds default, thus protecting the credit rating of the higher tranches. In theory the risk of the underlying debt is both reduced and distributed more efficiently among investors. See mezzanine finance.