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- Collateralized Debt Obligations
- The Handbook of Fixed Income Securities by Frank Fabozzi
- Collateralized Debt Obligations: Structures and Analysis, 2nd Edition (Wiley Finance)
- Collateralized Debt Obligations: Structures And Analysis
Collateralized Debt Obligations
Marselinus Asri. Download PDF. A short summary of this paper. Collateralized Debt Obligations. We would also like to thank Dr. MarselinusAsri, S. We sincerely hope this paper can be useful in order to increase our knowledge as well as our insights on " Collateralized Debt Obligations". We are fully aware that in this paper there are shortcomings and far from perfect words. Hopefully this simple paper can be understood for anyone who reads it.
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The market in such bonds emerged in the United States in the late s, first as a form of repackaged high-yield bonds. The market experienced sharp growth in the second half of the s, due to a combination of investor demand for higher yields allied to credit protection, and the varying requirements of originators, such as balance sheet management and lower-cost funding.
Put simply, a CBO is an issue of rated securities backed or 'collateralised' by a pool of debt securities. A CLO on the other hand is an issue of paper that has been secured by a pool of bank loans. As the market has grown the distinction between the two types of structure has become blurred somewhat. Practitioners have taken to defining different issues in terms of the issuer's motivation, the type of asset backing and the type of market into which the paper is sold, for example the commercial paper market.
Different structures are now more often categorised as being balance sheet transactions, usually a securitisation of assets in order to reduce regulatory capital requirements and provide the originator with an alternative source of funding, or arbitrage transactions, in which the originator sets up a managed investment vehicle in order to benefit from a funding gap that exists between assets and liabilities.
Balance sheet transactions are issuer driven, whereas arbitrage transactions are typically investor driven.
The ability of idiosyncratic risk in determining the formation of stock price becomes the focus of this research. Idiosyncratic risk as an indicator forming stock prices in the capital. Based on the above arguments, the formulation of this research are summarized as follows: in the context of Indonesia's capital market, whether there is an anomalous phenomena accrual, whether the formation of anomalous accrual and persistence of accruals affect stock prices and whether investors consider idiosyncratic risk in the decisions that shape stock prices.
Kahneman and Tversky introduced the theory of prospects and developed the theory of prospects to explain why a person makes certain decisions from his psychological side. Prospect theory denies expected utility theory that explains that their individual decisions are rational and linear. Prospect Theory explains the framing effect, certainty effect, insurance effect, and the endowment effect. As for, which is used as a reference point in calculating profit and loss always change from time to time.
Furthermore, the decision-makers perceive a person or prospect outcomes in the form of the value function. This is consistent with the main conclusions Kahneman and Tversky explains that the function of the values defined in terms of gains and losses. Value function explained that in making decisions, people tend to be risk-averse when it is in the domain of profit and risk-seeking when it is at a loss domain. The loss function is represented by a more concave and steep curve, while the function of the profit value is represented in the form of a convex curve and not so steep.
Relationships between variables in this study are based on prospect theory, the theory of real options, stock prices and the development of risk models. The common thread between these structures is that they are both backed by some form of commercial or corporate debt or loan receivable. The primary differences between the two types are the type of collateral backing the newly created securities in the CDO structure, and the motivations behind the transaction.
The growth of the market has been in response to two key requirements: the desire of investors for higheryield investments in higher-risk markets, managed by portfolio managers skilled at extracting value out of poorly performing or distressed debt, and the need for banks to extract greater value out of assets on their balance sheet, almost invariably because they are generating a below-market rate 4 of return.
By securitising bond or loan portfolios, banks can lower their capital charge by removing them from their balance sheet and funding them at a lower rate. The market has its origins in investor-driven arbitrage transactions, with bank balance sheet transactions a natural progression after banks applied securitisation techniques to their own asset base.
Balance sheet CDOs are structured securities that are usually backed with bankoriginated, investment grade commercial and corporate loans. Since this form of collateral is almost invariably loans, and very rarely bonds, these transactions are usually referred to as CLO.
In essence a special purpose vehicle SPV purchases loans or bonds directly from the originator or from the secondary market. SPVs have been set up in a number of ways, which include special purpose corporations, limited partnerships and limited liability corporations. An SPV will be bankruptcy-remote, that is, unconnected to any other entities that support it or are involved with it. The parties involved in a transaction, apart from the investors, are usually a portfolio manager, a bond trustee appointed to look after the interests of the investors, a credit enhancer and a back-up servicer.
Some structures involve a swap arrangement where this is required to alter cash flows or set up a hedge, so in such cases a swap counterparty is also involved. A further development has been the issue of synthetic CDO. Synthetic CLO structures use credit derivatives that allow the originating bank to transfer the risk of the loan portfolio to the market.
In a synthetic structure there is no actual transfer of the underlying reference assets; instead the economic effect of a traditional CDO is synthesised by passing to the end investor s an identical economic risk to that associated with the underlying assets that would have been transferred for a conventional 5 CDO.
This effect is achieved by the provision by a counterparty of a credit default swap, or the issue of credit-linked notes by the originating bank, or a combination of these approaches. In a credit-linked CLO the loan portfolio remains on the sponsoring bank's balance sheet, and investors in the securities are exposed to the credit risk of the bank itself, in addition to the market risk of the collateralised portfolio.
Therefore the credit rating of the CLO can be no higher than that of the originating bank. In this case, though, the collateral concerned is high-yield loans or bonds, rather than, for example, mortgage or credit card receivables.
The rating of each CDO class is determined by the amount of credit enhancement in the structure, the ongoing performance of the collateral, and the priority of interest in the cash flows generated by the pool of assets. The credit enhancement in a structure is among items securitinisedby investors, who will determine the cash flow waterfalls for the interest and principal, the prepayment conditions, and the methods of allocation for default and recovery. In a traditional ABS the servicing function is usually performed by the same entity that sources and underwrites the original loans.
These roles are different in a CDO transaction; for instance there is no servicer that can collect on non-performing loans. Instead the portfolio manager for the issuer must actively manage the portfolio.
This might include sourcing higher-quality credits, selling positions before they deteriorate, and purchasing investments that are expected to appreciate.
In essence portfolio managers assume the responsibility of a servicer. Therefore investors in CDOs must focus their analysis on the portfolio manager as well as on the credit quality of the collateral pool.
CDO structures also differ from other ABS in that they frequently hold noninvestment grade collateral in the pool, which is not a common occurrence in traditional ABS structures.
Finally CDO transactions are or rather, have been to date private and not public securities. Investors analysing CDO instruments will focus on particular aspects of the market. For instance those with a low appetite for risk will concentrate on the higher-rated classes of cash flow transactions.
Investors that are satisfied with greater volatility of earnings but still wish to hold AA or AAA-rated instruments may consider market value deals.
Arbitrage CDOs are further categorised as cash flow or marketvalue deals. Banks and other financial institutions are the primary originators of balance sheet CDOs.
These are deals securitising banking assets such as commercial loans of investment grade or sub-investment grade rating. Investors are often attracted to balance sheet CDOs because they are perceived as offering a higher return than, for example, credit card ABS at a similar level of risk exposure.
They also represent a diversification away from traditional structured finance investments. The asset pool in a balance sheet CDO is static, that is, it is not traded or actively managed by a portfolio manager. For this reason the structure is similar to more traditional ABS or repackaging vehicles. With these transactions, the originator has rather more freedom to actively trade assets in and out of the collateral pool, and sometimes a wider range of assets to choose from when trading.
Assets are marked-tomarket by the portfolio administrator on a regular basis, possibly as frequently as daily. Investors are attracted by the perceived fund management credentials of the originator, and there are also the theoretical advantages that come from the flexibility of being better able to manage losses when the market is experiencing a correction.
Market value deals frequently experience a ramp-up period when assets are built up in the collateral pool. This can take several months. There is also a liquidity or revolver facility, essentially a funding line distinct from the issue of notes, which is in place prior to the closing of the transaction and which is used to fund the acquisition of assets. The principal repayment of liabilities is funded when underlying assets are sold traded out of the pool, rather than when they mature.
These were introduced to meet differing needs of originators, where credit risk transfer is of more importance than funding considerations. Compared with conventional cash flow deals, which feature an actual transfer of ownership or true sale of the underlying assets to a separately incorporated legal entity, a synthetic securitisation structure is engineered so that the credit risk of the assets is transferred by the sponsor or originator of the transaction, from itself, to the investors by means of credit derivative instruments.
The originator is therefore the credit protection buyer and investors are the credit protection sellers. This credit risk transfer may be undertaken either directly or via an SPV. Using this approach, underlying or reference assets are not necessarily moved off the originator's balance sheet, so the approach is adopted whenever the primary objective is to achieve risk transfer rather than balance sheet funding. The synthetic structure enables removal of credit exposure without asset transfer, so may be preferred for risk management and regulatory capital relief purposes.
For banking institutions it also enables loan risk to be transferred without selling the loans themselves, thereby allowing customer relationships to remain unaffected.
MotivationsThe differences between synthetic and cash CDOs are perhaps best reflected in the different cost-benefit economics of issuing each type. The motivations behind the issue of each type usually also differ. The originators of the first synthetic deals were banks that wished to manage the credit risk exposure of their loan books, without having to resort to the administrative burden of true sale cash securitisation. They are a natural progression in the development of credit derivative structures, with single name credit default swaps being replaced by portfolio default swaps.
Synthetic CDOs can be 'de-linked' from the sponsoring institution, so that investors do not have any credit exposure to the sponsor itself. MechanicsA synthetic CDO is so called because the transfer of credit risk is achieved 'synthetically' via a credit derivative, rather than by a 'true sale' to an SPV.
However the assets themselves are not legally transferred to the SPV, and they remain on the originator's balance sheet.
The Handbook of Fixed Income Securities by Frank Fabozzi
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Collateralized Debt Obligations: Structures and Analysis, 2nd Edition (Wiley Finance)
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Mortgage-backed securities MBS are among the most complex of all financial instruments. Analysis of MBS requires blending empirical analysis of borrower behavior with the mathematical modeling of interest rates and home prices. The coverage spans the range of mortgage products from loans and TBA to-be-announced pass-through securities to subordinate tranches of subprime-mortgage securitizations.
Collateralized Debt Obligations: Structures And Analysis
A practical guide to the features and investment characteristics of CDOs In the bond area, collateralized debt obligations, which include collateralized bond obligations and collateralized loan obligations, are the fastest-growing sector. With this book as their guide, investment managers and institutional investors alike will learn how to analyze the risks associated with CDOs, create a portfolio of CDO products, and assess trading opportunities in the secondary market. Sign up to our newsletter today! Click here for more details Telegraph bookshop.
The CDO is "sliced" into "tranches" , which "catch" the cash flow of interest and principal payments in sequence based on seniority. Separate special purpose entities —rather than the parent investment bank —issue the CDOs and pay interest to investors. In the early s, the debt underpinning CDOs was generally diversified,  but by ——when the CDO market grew to hundreds of billions of dollars—this had changed.
Everyday low prices and free delivery on eligible orders. Written with the serious financial professional in mind, Structured Finance and Collateralized Debt Obligations, Second Edition skillfully puts this discipline in perspective. What is the definition of collateralized debt obligation? CDOs pool together individual fixed-income securities into a structured product and allocate a rate of riskbased on the type of debt.
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