Recently, you hear about problems with the sub-prime mortgages in USA. There is a high default rate among these mortgages. The high default has now affected the CDOs that are issued on these assets.
Here is a definition about CDOs from Wikipedia:
Collateralized debt obligations (CDOs) are a type of asset-backed security and structured credit product.
CDOs divide the credit risk on a portfolio of fixed income assets among different tranches. They issue senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches(unrated).
Losses are applied in reverse order of seniority and therefore junior tranches offer higher coupons.
Using CDO technology, from one portfolio of generally risky assets a range of products are created, from the risky equity tranche to the relatively lower-risk senior debt.
Lesson: There are many complicated financial products in the market. When things go wrong, it is quite difficult to sort out who takes the losses on the various tranches of the products. It is risky to invest in these products.
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