Financial Crisis – What Is a Cdo?
What is a CDO?
A CDO, (collateralized debt obligation) is ultimately an investment-grade security (bond) that is backed up by a pool of other bonds loans and other assets. It is a securitization of cash flows, or previously from previously illiquid assets into tranches. Basically a cash flow (such as a mortgage) is sold to a special purpose vehicle, then bonds are issued back by this cash flow and the CDOs are created. Tranches are created from the same group of bonds where the least risky tranches have a priority right on interest and principal paid by the underlying bonds. In return, these tranches receive the lowest rates of interest. The riskiest tranches are the first to absorb any defaults among the underlying bonds. In return, these tranches receive the highest rates of interest. Is a very valuable process since it created AAA assets.
What is synthetic CDO?
In Synthetic CDO It is a CDO that invests in credit default swaps (CDS) or other non-cash assets to gain exposure to a portfolio of fixed income assets. is not purchase of actual assets, there is no transfer of ownership or economic exposure to assets via credit derivatives (funded or unfunded). The credit exposure is transferred synthetically, via derivatives (credit event). The originating entity buys credit protection from investors, and they must be willing to pay the CDS premium. Synthetic CDOs allow credit risk management, capital relief, faster time to market (just a few weeks, as opposed to several months for cash deal, no requirement to fund the super senior component, confidentiality and a wider range of referenced assets possible.
Who bought them? Generally speaking, it was insurance companies, banks, pension funds, investment managers, investment Banks, and hedge funds. These