How does a synthetic funded CDO function?

A synthetic funded collateralized debt obligation (CDO) functions by using proceeds from the issuance of debt securities to invest in a combination of assets, often involving lower-risk securities. The fundamental mechanism behind this structure is that the CDO repackages various forms of debt, generally aiming to achieve a balance of credit risk and return for its investors.

In this context, the correct answer highlights that synthetic funded CDOs acquire low-risk securities with the proceeds they generate. By investing in these lower-risk instruments, the CDO can create a stable asset base that allows it to manage risk while still providing attractive returns to its investors. This strategy is essential for mitigating the potential volatility that might arise from higher-risk investments, making the CDO more appealing to a broader range of investors.

The other choices do not accurately capture the operational dynamics or investment strategies employed by synthetic funded CDOs. For example, they do not solely focus on mortgage-backed securities, nor do they strictly depend on high-risk investments or exclusively accept equity investments. This ensures that the selected answer provides a holistic view of how synthetic funded CDOs operate in the investment landscape.