Introduction to Securitization

KEY POINTS OF THE CHAPTER

• A collateralized debt obligation (CDO) employs securitization technology to pools assets and finance the purchase of those assets by the issuance of securities.

• A CDO is a generic name for collateralized loan obligations (the pool of assets consists of loans) and collateralized bond obligations (the pool of assets consists of bonds).

• A CDO may acquire assets in cash or synthetically.

• The cash asset CDO acquires assets in a traditional manner—raising the funding required equal to the size of the CDO and investing the same by acquiring the assets.

• The assets are acquired either from one originator (in the case of balance sheet CDOs) or from the market (in the case of arbitrage CDOs).

• For synthetic CDOs, the assets are acquired synthetically by using credit derivatives.

• The basic difference between cash and synthetic CDOs is the amount of funding raised and the manner of its investment: (1) a synthetic CDO does not have to pay for the assets it acquires unless it is required to do so as result of its position in a credit derivative; so funding is much less than in a cash CDO; and (2) in a cash CDO the assets are purchased while in a synthetic CDO the exposure to an asset is acquired by a position in a credit derivative.

• There are balance sheet and arbitrage CDOs and they may be of the cash or synthetic variety.

• The motivation for a balance sheet CDO is to transfer the risk of a particular pool of assets and thereby reduce the balance ...