Balance Sheet CDO

A balance sheet CDO allows one party to transfer credit risk to a group of investors through a special purpose vehicle (SPE).  Banks will sell loans to the SPE which will be underwritten and sold off to investors.  Investors will buy into different security classes, or tranches.  They lower the tranche, the less seniority, which translates into higher risk in the event of default.  The "equity" tranche will be the last class of investors which will receive their money back in default.  This class will also receive the highest yield to compensate for the risk.