What is a Leveraged Buyout? And how do CDOs invest in them?

When a company (either a public or private company) is acquired by a private equity firm, the transaction usually involves debt and or equity financing. This is called a leveraged buyout ("LBO"). The debt is a loan made to the company as part of the financing package (you could consider this to be similar to a mortgage made to a home buyer).

The equity investment is usually made by the private equity house. The debt financing is provided by an "arranging" bank based in the UK or Continental Europe. The arranging bank will then take this "debt" or "loan" to other banks and financial institutions including CDO managers to see whether they would like to take and hold part of it.

This process is called syndication. The institutions and funds that invest in the loans then become direct investors or lenders in the company. There are different types of LBO related debt products.

They can be distinguished in terms of type (senior bank loans, mezzanine loans, bonds), security ranking (senior ... more.

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