Collateralized Debt Obligations

Summaries

A CDO is an ABS collateralized by a pool of debt obligations.

CDO has 3 different tranches:

1)      Senior – floating rate

2)      Mezzanine – fixed rate

3)      Equity – absorb prepayment and credit risks

After the interest to senior and mezzanine tranches are paid, the rest is paid to the equity tranche.

Interest swap is required to get enough rating.

1. Source of Funds

Cash Flow CDO – pay interest and principal to holders by the cash flow generated by the asset

Market Value CDO – actively trading asset to generate cash flow and realize capital gains

2. Motivations

Arbitrage vs balance sheet driven

3. Funding

Cash CDO vs Synthetic CDO