What Should the Different CDO Tranches Tell an Investor?

The risk characteristics of a CDO’s tranches are reflected in their names. Senior debt, for example, has a better credit rating than mezzanine and junior debt. If the loan defaults, the senior bondholders receive payment first from the collateralized pool of assets, followed by bondholders in the subsequent tranches in order of credit rating, with the lowest-rated credit receiving payment last. In general, the senior tranches are secure because they have the first claim on collateral.