What is a primary difference between unfunded CDOs and funded CDOs?

The primary distinction between unfunded CDOs (Collateralized Debt Obligations) and funded CDOs lies in the mechanics of their financing arrangements. Unfunded CDOs are structured in a way that they do not receive a cash purchase price upfront; instead, they rely on the future cash flows from the underlying assets to meet their obligations. This means that the cash that eventually funds the CDO will come in over time as the reference assets generate income, rather than being initially provided as a capital investment.

In contrast, funded CDOs have an initial funding pool, which is raised from investors and is used to purchase the underlying assets outright. This initial capital allows the funded CDO to immediately invest in securities, rather than waiting for cash flows to come from the referenced instruments.

This difference in structure leads to distinct risk profiles and liquidity characteristics between the two types of CDOs, but the key point is that unfunded CDOs do not involve an immediate purchase price. Understanding this fundamental aspect is crucial for analyzing the financial mechanics of different investment vehicles in alternative investment strategies, particularly in the context of structured finance.