What is a Collateralized Loan Obligation?
A loan backed by collateral or security is less risky than an unsecured loan. In the banking industry, a collateralized loan obligation is a loan that is backed by assets in a financial institution, including securities or bonds.TranchesInterest income and loan repayments made to the financial institution are used to back specific securities in a financial institution, creating a collateralized loan obligation instrument. These interest payments and loan repayment groupings are called tranches.Cash Flow CDOIf the security instruments, the collateral, are not actively traded and therefore valued by the financial institution’s incoming defaults, they are considered cash flow CDOs (collateral debt obligation), or collateral loan obligations.Market ValueThe market value of collateral loan obligations is based on the market returns of the collateral pool.
A collateralized loan obligation (CLO) is a financial process to bring together loans to many different businesses into one package which is then resold to multiple lenders. The aim is to make the financial system more efficient by overcoming the mismatch between the different needs of individual borrowers and lenders. However, in some ways the CLO increases complexity and has been blamed for contributing to the banking crisis which emerged in 2007. Strictly speaking, a collateralized loan obligation only involves commercial business loans. There are similar schemes which work the same way using bonds and mortgages, and some which combine two or more types of loans. The terms used for these schemes are often confused or used interchangeably. However, the basic system and the benefits and drawbacks are the same in all cases. To understand why the collateralized loan obligation developed, you need to remember that some borrowers are considered more likely to repay than others. Some lende
