CDO squared is a type of structured finance product that is created by using tranches of other CDOs as collateral. It represents a second level of securitization, where the underlying assets are not individual loans or bonds, but tranches of other CDOs. This structure adds an additional layer of complexity to an already complex financial instrument, making it even more challenging to assess the underlying risks.

Imagine we have several CDOs, each composed of various debt instruments like mortgages, corporate bonds, and other loans. Now, instead of creating a new CDO from these original debt instruments, we take specific tranches (usually the riskier ones) from multiple CDOs and use them to create a new CDO. This new instrument is a CDO squared.

Why the other options are incorrect:

A. Collateralized Loan Obligations (CLOs): While CLOs are a type of CDO, they are specifically backed by a pool of corporate loans. They are not typically created by securitizing tranches of other CDOs.

B. Synthetic CDOs: These are CDOs that use credit default swaps and other derivatives to gain exposure to a portfolio of fixed income assets, rather than actually owning the assets. While complex, they are not specifically created by securitizing tranches of other CDOs.

D. Mortgage-Backed Securities (MBS): These are securities backed by a pool of mortgages. They represent the first level of securitization, not a securitization of CDO tranches.