CLO, managing business finance Essay Example | Topics and Well Written Essays - 1750 words

CLO, managing business finance - Essay Example The feeling among many investors is that the development on new regulations to reduce the risk that comes with these forms of loans will reduce the chances of getting into a financial crisis. In 2014, it is evident that investors have ventured into the form of loan due to its higher returns as compared to other forms of loans. In this perspective, we seek to analyse the possible reasons for this trend and how this is likely to impact financial flows in the global arena. Collateralized loan obligation is defined as a form of low interest loan that comprises of a pool of debt backed up by some form of security. To design a CLO, commercial group different loans together and sectionalize them into different parts. Each section of the loan bears a different risk, some having higher risks than others. The rationale is that those who pick higher risk sections have higher returns while those who pick lower risk portions have lower returns. Another point to note is the way that cases of default are handled. When defaulters fail to repay the loan, the investor with high risk loan gets less money than one who has a lower risk section. The principle behind the formation of the CLO is to increase the lending willingness of the investors and to lower the interest costs. The banks accomplish these loans through a tranch structure in which different classes of borrowers dear different risks and acquire different level of returns (Pauley & Kroszner, 2012). This loa n structure operates much similar to the home mortgage loans that existed in the 1980s. At this time, companies that had good credit ratings were allowed to borrow at lower prices while others borrowed from the banks at much higher interest rates. For this reason, CLO gained popularity prior to the financial crisis in 2008. The global financial crisis of 2008 is was the cause for the loss of popularity for the CLOs in the world. A