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Arbitrage CDO: A CDO that intends to earn profits, that is, the difference between the rate of return on its assets and the cost of funding the liabilities, usually by investing in diversified assets that have a degree of risk, and funded by a liability structure that has appropriate level of leverage. While each of the senior classes of liabilities get relatively higher coupons, the residual profits or losses are taken by the equity class of the CDO. See also under collateralized debt obligations. Compare with balance sheet CDO.