Collateralized Debt Obligations: Structures and Analysis, Second Edition

CHAPTER 2

Cash Flow CDOs

As explained in Chapter 1, arbitrage CDOs are categorized as either cash flow transactions or market value transactions. The objective of the asset manager in a cash flow transaction is to generate cash flow for CDO tranches without the active trading of collateral. Because the cash flows from the structure are designed to accomplish the objective for each tranche, restrictions are imposed on the asset manager. The asset manager is very limited in his or her authority to buy and sell bonds. The conditions for disposing of issues held are specified and are usually driven by credit risk management. Also, in assembling the portfolio, the asset manager must meet certain requirements set forth by the rating agency or agencies that rate the deal.

In this chapter we will discuss cash flow transactions. Specifically, we will look at the distribution of the cash flows, restrictions imposed on the asset manager to protect the noteholders, and the key factors considered by rating agencies in rating tranches of a cash flow transaction. In this chapter we focus on establishing a basic understanding of cash flow CDO deals using examples. Only a brief mention will be made of deals backed by other types of collateral. In the following eight chapters, we focus on other collateral types. Chapters 3, 4, and 5 we focus on loan collateral and loan-backed deals (CLOs). In Chapters 6, 7, and 8 we focus on structured finance collateral (MBS/ABS/CMBS/CDO), and the deals backed ...