Structured debt refers to a type of financing that involves complex financial instruments and arrangements designed to meet specific needs of borrowers and lenders. These arrangements often involve multiple layers of debt securities, such as bonds or loans, with varying terms and conditions tailored to the preferences and risk profiles of different investors.
One common form of structured debt is collateralized debt obligations (CDOs), which bundle together various types of debt, such as mortgages, into a single security. These securities are then divided into tranches, each with its own risk and return profile. Another example is asset-backed securities (ABS), where cash flows from a pool of underlying assets, such as loans or receivables, are used to repay investors.
Structured debt can offer benefits such as diversification, risk management, and access to capital markets for borrowers. However, it can also be complex and opaque, leading to challenges in assessing risk and potential for market disruptions, as seen during the 2008 financial crisis.
Regulators closely monitor structured debt markets to mitigate systemic risks and ensure investor protection. Additionally, investors need to conduct thorough due diligence to understand the risks associated with these instruments before investing.
