Talk:Collateralized debt obligation

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To-do list for Collateralized debt obligation: edit · history · watch · refresh

Last four edits are from user Nile_Hef:

  • short paragraph on 'Toxic Waste' and lawsuits following mis-selling allegations
  • Software added S&P CDO toolkit
  • Reference guides added recent articles in RISK and The Economist
  • added 'loan contracts' to the basket components

Apologies for the anonymous edits, I seem to be having difficulty with 'persisting' my login in Opera - Nile

The section on the "subprime meltdown" is pretty loose with the facts and contains a number of unsupported statements. The one citation that is there is to a pretty shoddily written Fortune article and doesn't really support the statements it's supposed to support. Bond Head 00:15, 2 July 2007 (UTC)

Cayman Island trust statement should be referenced or explained. Who is watching this article? The guy should be shot

Is it a snipe at the Everquest incoporation in the Cayman Islands?


Would be nice if this page got into deeper technical detail. How does this really work? What is considered an asset and what is a liability within a CDO? —Preceding unsigned comment added by 64.47.152.254 (talk) 23:57, 28 November 2007 (UTC)

[edit] Backup of text removed by Chrerick

The following was text removed by User:Chrerick as part of a major rewrite. I wanted to keep a copy here so it doesn't get lost in the article's edit history. Finnancier (talk) 12:35, 12 February 2008 (UTC)

[edit] Rewrite

The manufacturer of this entity, typically an Investment Bank, takes a cut of the value of the inventory and obtains management fees. The bank also typically does not have to maintain the underlying assets on it's own accounting ledgers, a significant financial advantage. An investment in a CDO is therefore an investment in the cash flows of the assets, and the promises and mathematical models of this intermediary, rather than an a direct investment in the underlying collateral. This differentiates a CDO from a mortgage or a mortgage backed security (MBS).

Typically, the highest CDO tranche income rates are paid to those that will accept the highest credit default risks.

The "arbitrage"[1] of a CDO involves the spread between the income generated from the higher-yielding assets the CDO holds in its portfolio and the lower-yielding liabilities the CDO issues. Since the CDO issues mostly high-rated debt, the cost of the debt is less than the before-default cash flow generated by the CDO's assets. The yield on the CDO's assets minus the cost of the CDO's liabilities and expenses is called "excess spread", i.e.,

excess spread = yield - \sum interest payable to each tranche - management fees and expenses

Most of the excess spread is made available to equity investors in the CDO. The excess spread of the CDO must be sufficiently large to generate an attractive return for equityholders and this is a key consideration in the structuring of the CDO during the underwriting process. If losses on the CDO's assets are low, the spread can be substantial and lead to equity returns of 10% or higher but even a low number of defaults on the CDO's assets can eliminate the CDO's excess spread and cause equityholders to lose up to their entire investment. If losses exceed the size of the equity tranche, losses are next applied to the most junior debt tranche and so on in reverse order of seniority.

The distribution of cash flow from the CDO's assets to the CDO's tranches is modeled in cash flow waterfalls. There are separate waterfalls for interest and principal. Cash flow is first used to cover top-priority expenses such as administrative fees and hedge costs. Next, cash flow is distributed sequentially from the most senior tranche to the most junior tranche.

CDOs are subject to certain interest coverage or overcollateralization tests. For instance, an overcollateralization coverage test may require the CDO to maintain a minimum ratio of assets in portfolio to senior debt outstanding. If the ratio is not maintained, cash flow is diverted to pay principal on the senior tranche. Missed interest payments to mezzanine tranches that result may not lead to default as many mezzanine tranches include pay-in-kind features, in which missed cash interest payments are added to the principal of the tranche.

CDOs may include subordinate management fees and subordinate expenses.

[edit] "Blame"

From this article (and, notably, unsourced at the time of this writing): "Some news and media commentary blame the financial woes of the 2007 credit crunch on the complexity of CDO products."

Well, apparantly according to the chairman of the Financial Services Committee: A Liberal Wit Builds Bridges to the G.O.P., By DAVID M. HERSZENHORN,Published: May 13, 2008 (http://www.nytimes.com/2008/05/13/washington/13barney.html?th&emc=th). This should be revised and much better cited in the article. Shoreranger (talk) 15:43, 13 May 2008 (UTC)