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Introduction to Collateralized Debt Obligations
Collateralized Debt Obligations or CDOs are financial instruments where cash bonds or loans are grouped together in a package and resold to investors. Alternatively, CDOs can be created synthetically through the use of credit default swaps. This article looks at the basics of the cash and synthetic CDO.
Generic Cash CDO: Features and Characteristics
The features and characteristics of a generic cash flow CDO are illustrated In Figure 1 below:
- The originator legally creates a special purpose vehicle, (“SPV”). The SPV is a trust.
- The originator sells the assets to the trust. In a plain vanilla structure, the asset can be bonds or loans.
- The trust then issues notes to investors in the form of tranches. These notes are backed or collateralized by the assets sold to the SPV. Investors choose their tranche based on desired rates of return and credit quality.
- The SPV is said to be” bankruptcy remote.” If the originator goes bankrupt, then creditors of the originator, or the bank in this example, may not legally stake claims to the assets within the SPV.
- The bank continues to service the loans and earns a fee for doing so.
- CDOs are nothing more than asset backed securities. CDOs are a form of securitization which issue notes in tranches--classifying this as structured finance rather than a securitization.
- There are often credit enhancements, such as an excess credit spread, senior subordinate structure, over collateralization, or a third party guarantee, such as monoline insurance.
Other Parties Involved in a CDO
There are several other parties involved in the CDO. These include:
- The trustee who oversees the compliance of the transaction.
- The servicer which services the assets e.g. collecting interest payments.
- The asset manager is responsible for managing the assets in the trust.
- The guarantor that guarantees the performance of the trust.
- The rating agency that supplies the credit rating.
Issuer and Investor Applications
Investors use CDOs for a variety of reasons, some of which include:
- Reduction of regulatory capital (for banks).
- The sale of assets raises money therefore it is a funding tool.
- The originator can manage both credit and market risk.
- Fee income – the originator earns a fee.
Investors use CDOs for a variety of reasons, some of which include:
- Diversification – The CDO is backed by a well diversified portfolio of assets.
- Liquidity - Tranches tend to be more liquid than individual bonds.
- Asset Liability Management - Offers investors the ability to align their assets with their liabilities.
CDO’s Galore
Other common structures/names for CDOs in the market include:
- Cash flow CDOs – The underlying collateral pays for the interest to the investors.
- Collateralized Bond Obligations (CBOs) - The underlying collateral are bonds.
- Collateralized Loan Obligations (CLOs) – The underlying collateral are loans.
- Market Value CDOs – The asset manager tries to actively manage the assets to achieve a superior return.
- Arbitrage CDOs – Not really an arbitrage but the additional assets under management earn a fee.
- Structured finance CDOs – The collateral is MBS or ABS.
- Multisector CDOs – The underlying securities can be MBS, ABS, bonds and or loans.
To read this entire column, which includes synthetic CDO and risks, click here :
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The Financial Side of Project Decisions
Decisions, decisions....
Ever wonder how to determine the viability of a project?
Is it a good idea from a financial viewpoint?
What exactly do you need to consider in making your analysis?
Will this product (service, lease, agreement) generate enough cash to justify the investment?
The key to profitability for any business is knowing how to put money where it will make money.
- Making the right decision on business investments is key to running a profitable business.
- Understanding the financial side of a project decision is key to making the right investments.
Managers routinely analyze financial decisions using approaches that give them the wrong result. Accounting data are useful, but not in project analysis. Using the traditional measures of profitability, payback and other common rules of thumb will often lead to the wrong decision – causing the firm to make bad investments or, to miss good ones.
Having clients express the need for such a class is the reason why GFMI created: Understanding the Financial Side of a Project Decision.
In this class, you’ll learn:
- How to avoid common pitfalls in making project decisions
- How to make the right ones
- How to analyze a project decision, using a combination of financial theory and practical case analysis
- Cash flow versus profit
- Marginal Cost versus Overhead
Regardless of the industry you’re in, whether it be financial, manufacturing of widgets, service provider, whatever…you have managers who have to make decisions that will directly affect the bottom line as well as your success score card.
For more information on a class that specifically addresses some of the issues and misunderstandings surrounding making sound business decisions, click here:
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Susan is a market professional specializing in equity and fixed income valuation, corporate finance, economics and wealth management, with a focus on statistical and analytical methods and techniques. She also instructs the NYSSA’s CFA Level 1 training course and Quantitative Review Workshop.
With a previous career as Managing Editor for TheStreet.com, Susan was responsible for Street Insight, a financial web site that provides real-time market commentary written by, and dedicated to, professional money managers, particularly hedge funds. She also was the former Global Director of Securities for the NY Institute of Finance.
A financial practitioner, Susan’s background as an investment analyst and advisor encompasses more than two decades and covers a wide range of financial instruments and clients.
Previous positions include: Director of Research for Veronis Suhler, a merchant/investment bank, where she focused on the media and communications industries; and President of Ananda Advisors in New York, providing investment and advisory services to institutional and private investors. Until 1992, she was Vice President, Investment Strategy for Kidder, Peabody & Co.
As an Economist for Washington Analysis Corp., then a subsidiary of Prudential Securities, Susan focused on macroeconomic influences affecting fixed income, equity, and commodity markets.
Most impressively, Susan has the distinction of being appointed, in 1982, by United States Secretary of Labor to the U.S. Department of Labor Business Research Advisory Council-- which oversees construction and release of economic indicators, including the Consumer Price Index and employment data. She served on the Council through both Reagan Administrations and the first Bush Administration, including as Chair of the Committee on Price Indexes.
Susan’s credentials have entitled her to an extensive track record of public speaking, media relations, and training. A specialist in Wealth Management and the Capital Markets, Susan has delivered programs in locales ranging from New Delhi to New York. She has addressed an international economic conference on financial markets and corporate restructuring, with speakers including: Hon. Alan Greenspan, Chairman of the Federal Reserve; Hon. Janet Yellen, Chairman of the Council of Economic Advisors; Ambassador Charlene Barshefsky, U. S. Trade representative; and other key players in world financial markets.
Her financial market acumen has made her an oft-quoted expert across a variety of news media, including television (CBS Evening News, CNN, Moneyline, CNBC, FNN); newspapers (New York Times, London Times, The Australian); financial news publications (Wall Street Journal, Business Week, Tokyo Kabushiki Shijo Shimbun); radio (Associated Press and Dow Jones Radio) and the major newswires.
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| Interested in having Susan deliver a program for your firm? |
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As we enter Q4, many of our clients are scurrying to satisfy their annual continuing education requirements—a common year-end event. For those of you who still need a class to earn those 7 or more credit hours, we might be able to help!
GFMI has a few open training days before year end to assist your auditing, accounting, and other professional staff, who need CPE credits. Our most popular topics for CPE audiences tend to include:
- Credit Derivatives and CDOs
- Fixed Income (various levels of sophistication)
- Portfolio Management
- Risk Management
- VaR
- Derivatives
Don’t delay! 2007 will be here before you
know it! |
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New Credit Module Enhancements for Magellan On-Line Learning
At the end of October, our e-learning partner, Chisholm Roth, will be adding 5 new credit modules to their Magellan On-Line Learning package:
- Cash Flow Analysis and Cash Flow – Early Warning Signs
- Lending to Small Businesses
- Credit – Client Relationship Skills
- Agri – Lending
- Credit and Lending – Construction, Builders and Property Developers
Also for release at the end of the month, Chisholm Roth has a new module which covers an Overview of Basel II, an ever popular and current topic.
Stay tuned for information on 9 additional credit modules that are currently in development, covering a variety of credit topics, including:
- Project Finance and Break Even Analysis
- Large Company Analysis and Valuation
- Credit Risk Rating and Grading
- Credit Specialized Lending – Structured Finance and Project Finance
- And more…
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Joint effort with AMF results in full-house for Fixed Income event:
On September 25, GFMI and The Asset Managers Forum (AMF) joined forces in providing a special educational event for the AMF members. This first program, Fixed Income – Level One, was offered to securities industry professionals who are employed by AMF member firms nationwide.
The result? Over 100 participants packed the state-of-the-art training facility, located at the Bond Market Association headquarters, spilling over into another training room fully equipped with live streaming video and exceptional audio setup. Content covered the basics of:
- Fixed Income Markets, players and regulators
- Products: features, characteristics, applications and risks
- Calculation of Present Value, Future Value and Accrued Interest
- Introduction to Portfolio Management
The event garnered great reviews and comments from the attendees. GFMI and the AMF are presenting their next joint seminar, “Fixed Income – Level Two” on Friday, December 1, 2006. To register or for more information, email: www.theassetmanager.com.
Who is the AMF?
The AMF was formed in 1997 in cooperation with The Bond Market Association, by a group of securities processing professionals. It is comprised of leading asset management firms, custodians, pricing and information vendors and industry utilities. The AMF is a response to a long-standing need on the Street; namely, the opportunity for sell side and buy side operations professionals to jointly pursue the development of mutual industry-wide securities processing or operations projects and enhancements.
Membership in The Asset Managers Forum provides excellent networking and educational opportunities, and access to others who face similar challenges and changes in the industry. The AMF will host additional educational events. For more information log on to their website: www.theassetmanager.com.
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