A debt security that is collateralized (i.e., backed) by various types of debt obligations like bonds and loans of varying credit quality. Essentially, it is an investment-grade bond or debt security that is secured by a pool of variously rated debt securities such as highly rated bonds or junk bonds (high-risk, high return bonds). Underwriters of collateralized bond obligations (CBOs) package a wide and diversified pool of securities and then divide the pool into consistent tiers (top, middle, and bottom), ranging from ones representing the higher credit quality collateral (which normally pay the lowest rate) to those representing the lowest credit quality collateral (which pay the highest interest rate). The middle tier is backed by bonds riskier than those in the top tier and less risky than those in the bottom tier.
The collateralized bond obligation is also known as a collateralized debt obligation (CDO).
