Collateralized Debt Obligation

Collateralized Debt Obligation (CDO ) is an umbrella term for financial instruments that belong to the group of the asset-backed securities ( asset backed securities ) and structured credit products. CDOs consist of a portfolio of fixed income securities. These are divided into several tranches, which are usually referred to in order of their seniority as a senior tranche, mezzanine tranche and equity tranche. The risk of default increases - due to the subordinated treatment in case of failure - with decreasing rating, therefore provides the equity tranche as compensation the highest interest rate. CDOs are financial products ( for example, investments in conduits) and an important refinancing for banks in the capital market. In the wake of the financial crisis from 2007 they are coming under fire because of their use by high-risk loans were placed as a supposedly safe investments on the capital market to a great extent.

Construction

CDOs vary in structure and the underlying portfolio, but the basic structure is always the same.

• A special purpose entity (English Special Purpose Vehicle, SPV ) acquires a portfolio of mortgage-backed securities and / or high-yield bonds.
• The SPV issues different classes of unrated bonds, and the proceeds thereof are used for the acquisition of the loan portfolio. The various bonds entitle the holder to the cash flows from the portfolio of the SPV. The distribution depends on the ranking of the bonds. Senior tranches are serviced before the mezzanine and this before the equity tranche. Losses must have been first borne by the equity tranches. In order to offer individual tranches very different risk and reward profile, although they are all based on the same underlying portfolio of credit instruments.
• Losses are distributed in reverse order of ratings. The tranche with the best rating is protected by the tranches with lower ratings. The equity tranche carries the highest risk of failure and offers the highest coupons to offer compensation for the risk greatly increased.

Fundamental point is that the SPV will not sell the securities themselves ( they remain in the possession of the SPV). Sold cash flows ( ie about interest and principal payments) on these securities. As a result, difficult or impossible to tradable securities into tradable products are converted.

A special form of so-called " synthetic" CDOs: The SPV has no mortgage-backed securities or bonds, but financial derivatives, usually so-called credit default swaps ( CDS). In fact, this function as credit default insurance. The owner of such a synthetic CDO is thus a buyer or a seller of risks of guarantees (so-called protection seller ). Mixed forms of "normal" and "synthetic" CDOs are possible.

The CDO managers, typically an investment bank or asset manager, earned in the issue a commission and a management fee over the term of the CDOs.

Criticism

From the media and scientists the complexity of CDO products, the lack of transparency of products, the failure of the rating agencies in the proper valuation of these instruments and the lack of supervision of the state bodies for the financial turmoil of the financial crisis will be held responsible from 2007.