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What is Collateralized Bond Obligation?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 09 December 2016
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    Conjecture Corporation
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A collateralized bond obligation is a bond understood to be of investment grade. The bond obligation is backed with the use of a pool of junk bonds, which are generally not considered to be investment grade. However, the combination of several junk bonds that represent different types of credit quality are often considered sufficient to provide the collateralized bond obligation the status of being considered an investment-grade bond.

In most cases, the junk bonds that are utilized to back a collateralized bond obligation will be corporate bonds. The several different tiers in credit quality of the collection of bonds helps to provide an overall stability to the backing, since there is a good chance that most if not all of the bonds will maintain their worth for the duration of the bond issue. Because of the diversity of the backing instruments, a collateralized bond obligation can be an attractive option for an investor.

Commonly referred to as a CBO, the collateralized bond obligation is usually issued with credible interest rates, although the rates are not always the best on the market. Part of the determination of the rate of interest that is extended has to do with the exact makeup of the junk bonds that back the obligation. If the majority of the bonds tend to exhibit healthy interest rates, the collateralized bond obligation will reflect those circumstances.

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As with any type of bond issue, a collateralized bond obligation does carry some element of risk. However, it should be noted that the risk is somewhat minimal when considered in light of the interest rate that is usually applicable. A collateralized bond obligation is not an investment that is likely to attract investors who want to make a huge profit from the venture, but smaller investors often find this type of bond obligation with its modest return to be worth consideration. Brokers who deal in bond issues often are able to steer clients to bond obligations of this type that offer excellent potential.

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