obligation

noun ob·li·ga·tion \ ˌä-blə-ˈgā-shən \
Updated on: 9 Nov 2017

Definition of obligation

1 : the action of obligating oneself to a course of action (as by a promise or vow)
2 a : something (such as a formal contract, a promise, or the demands of conscience or custom) that obligates one to a course of action
  • made an obligation to pay their children's college expenses
b : a debt security (such as a mortgage or corporate bond)
c : a commitment (as by a government) to pay a particular sum of money; also : an amount owed under such an obligation
  • Unable to meet its obligations, the company went into bankruptcy.
3 a : a condition or feeling of being obligated
  • felt an obligation to vote
b : a debt of gratitude
  • returned the favor as an obligation
4 : something one is bound to do : duty, responsibility
  • countries in which military service is an obligation
  • fulfilled their familial obligations

Examples of obligation in a Sentence

  1. She believes that all people have a moral obligation to defend human rights.

  2. He argues that people in a community have certain obligations to each other.

  3. She failed to fulfill her obligations as a parent.

Recent Examples of obligation from the Web

These example sentences are selected automatically from various online news sources to reflect current usage of the word 'obligation.' Views expressed in the examples do not represent the opinion of Merriam-Webster or its editors. Send us feedback.

First Known Use of obligation

14th century


Financial Definition of OBLIGATION

collateralized debt obligation

What It Is

A collateralized debt obligation (CDO) is a security that repackages individual fixed-income assets into a product that can be chopped into pieces and then sold on the secondary market. They are called collateralized because the assets being packaged -- mortgages, corporate debt, auto loans or credit card debt- - serve as collateral for investors.

How It Works

CDOs are described as structured asset-backed securities because they pay cash flows to investors in a prescribed sequence, based on how much cash flow is collected from the package of assets owned.

The CDO is split into different risk classes known as tranches. Interest and principal payments are made in order of seniority so that senior tranches have the least risk. Junior tranches, which have higher default risk, usually have higher coupon payments.

A typical CDO may consist of a portfolio of 100 corporate bonds and have an average S&P rating of B+. Assuming a total portfolio size of $300 million, the CDO might have six classes or tranches:

collateralized debt obligation

The Class A senior tranche will offer investors the lowest yield since it has the highest S&P rating. The equity tranche would have the highest yield since it is the most risky component of the deal structure.

Why It Matters

Collateralized debt obligations allow banks and corporations to sell off debt and free up capital to re-invest or loan. The downside of CDOs is that the loan originators have little incentive to collect when loans in the package come due since these loans are now owned by other investors. This may make originators less disciplined in adhering to strict lending standards.

Another downside of CDOs is the complexity of these products. Buyers may not know exactly what they are buying or whether the package is really worth the price. The opaqueness and complexity of CDOs can result in a market panic if investors lose confidence and CDOs become more difficult to re-sell. This was the scenario during the Sub-Prime Crisis of 2007 when many banks were forced to take sizable write-downs on their CDO holdings.


collateralized mortgage obligation

What It Is

A collateralized mortgage obligation (CMO) is a fixed income security that uses mortgage-backed securities as collateral.  Like other structured securities, CMOs are subdivided into graduated risk classes, called tranches that vary in degree based on the maturity structure of the mortgages.

How It Works

When an investor purchases a CMO, he or she purchases some class or tranche of the security whose risk depends on the maturity structure of the mortgages backing it. These tranches are usually designated as A, B, C, etc. and increase in degree of risk as the letters ascend.

To illustrate, Class A of a CMO would be the highest risk tranche offering the highest rate of return based on mortgages that still have a long term until full repayment by the borrowers. For this reason, they are exposed not only to interest rate and default risk but also to prepayment risk, the risk that borrowers will pay off the mortgage in advance of the mortgage term (e.g. 15 years, 30 years, etc.). Class A in this CMO will be the first of all of the tranches to absorb losses from borrowers' failure to make payments. Class A will, however, also be the first to receive money from prepayments.

By contrast, Class C of a CMO would carry the least risk for the holder, but offer a much lower rate of return. This is because the mortgages backing it are likely approaching their full repayment, meaning that the holder is solely receiving interest, and perhaps some principal payments from the remainder of the mortgage term. For this reason, Class C CMOs will receive little or no returns from prepayments.

Why It Matters

Collateralized mortgage obligations offer investors an opportunity to profit from a diversified, and therefore risk-reduced, set of mortgage-backed securities. CMOs subdivisions into graduated classes of risk cater to the risk preferences of prospective investors. Moreover, similar to collateralized loan obligations (or CLOs), CMOs provide a way for lending institutions to reduce interest and default risk and increase their lending power by transferring debt to investors in the form of structured securities.


obligation

What It Is

An obligation is a legal requirement to fulfill a responsibility. In the finance world, this often involves making specific payments by specific dates and/or ensuring that a company meets certain performance requirements.

How It Works

A borrower, for example, has an obligation to make payments of an agreed-upon size on an agreed-upon date. A company may have an obligation to provide certain disclosure to the Securities and Exchange Commission (SEC). A board may have an obligation to pay an executive a certain amount of money if certain events occur, and a lender may have an obligation to charge a certain amount of loan interest for a fixed period of time, even if it can get a higher interest rate later on other loans.

Why It Matters

In the finance world, obligations are everywhere, and the fulfillment or lack of fulfillment (or even speculation about the lack of fulfillment) of those obligations has a significant impact on the value of the entities that must meet or depend on the obligations. When a party does not fulfill an obligation, the other party to the contract generally has the right to seek recourse in court.



OBLIGATION Defined for English Language Learners

obligation

noun

Definition of obligation for English Language Learners

  • : something that you must do because of a law, rule, promise, etc.

  • : something that you must do because it is morally right


OBLIGATION Defined for Kids

obligation

noun ob·li·ga·tion \ ˌä-blə-ˈgā-shən \

Definition of obligation for Students

1 : something a person must do because of the demands of a promise or contract
  • Make sure you know your rights and obligations before you sign.
2 : something a person feels he or she must do : duty
  • I can't go because of other obligations.
3 : a feeling of being indebted for an act of kindness Don't feel any obligation to return the favor.

Law Dictionary

obligation

noun ob·li·ga·tion \ ˌä-blə-ˈgā-shən \

legal Definition of obligation

1 : a promise, acknowledgment, or agreement (as a contract) that binds one to a specific performance (as payment); also : the binding power of such an agreement or indication
  • held that the amendment did not unconstitutionally impair the obligations of contracts
  • Davis v. American Family Mut. Ins. Co., 521 N.W.2d 366 (1994)
2 : a debt security (as a corporate or government bond)
collateralized debt obligation
: a security backed by a pool of diversified securities that usually do not include mortgages
collateralized loan obligation
: a security backed by a pool of commercial loans
collateralized mortgage obligation
: a bond collateralized by a pool of mortgage obligations or pass-through securities and paid according to the maturity and amortization schedule of its class and not directly from the underlying obligations called also CMO
3 : what one is obligated to do, satisfy, or fulfill: as
a : a commitment to pay a particular amount of money
  • does not create a debt, liability, or other obligation, legal or moral
  • State v. Florida Dev. Fin. Corp., 650 So. 2d 14 (1995)
; also : an amount owed in such a commitment
b : a duty arising from law, contract, or morality
  • had a legal obligation as an employer
  • a contractual obligation
4 in the civil law of Louisiana : a relationship that binds one party to a performance (as a payment or transfer) or nonperformance for another party — see also contract, offense, quasi-offense
Note: An obligation under civil law may arise by operation of law, naturally, or by contract or other declaration of will. The elements of an obligation are: the parties, an object, the relationship by virtue of which one party is bound to perform for the other's benefit, and, in the case of conventional obligations, a cause.
conditional obligation
: an obligation that is dependent on an uncertain event
conventional obligation
: an obligation taking the form of a contract
heritable obligation
: an obligation that may be enforced by the successor of the obligee or against the successor of the obligor
joint obligation
1 : an obligation binding different obligors to a performance for one obligee
2 : an obligation binding one obligor to a performance for different obligees
Note: In civil law, one of two or more obligors in a joint obligation is only liable for his or her portion of the performance.
natural obligation
: an obligation arising from moral duty that is implied but not enforceable by the law
several obligation
1 : any of the obligations binding different obligors to separate performances for one obligee
2 : any of the obligations binding an obligor to separate performances for different obligees
solidary obligation
: an obligation under which any of two or more obligors can be held liable for the entire performance (as payment of a debt)
Note: Solidary obligation is similar to joint and several liability in common law.


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