Collateralized Debt Obligation

Salman Khan Premkumar Nadar

201277 2012102

Collateralized Debt Obligation (CDO)

A CDO is an asset backed security (ABS) whose underlying collateral is typically a portfolio of bonds (corporate or sovereign) or bank loans.CDO can be classified according to debt type:
Collateralized loan obligation (CLO); Collateralized bond obligations (CBO); Collateralized mortgage obligations (CMO)

The first CDO was created in 1987 by the famous Drexel Burnham Lambert, for a $100 million loan.

Collateralized Debt Obligation (CDO)

A CDO cashflow structure allocates interest income and principal repayments from a collateral pool of different debt instruments to a prioritized collection (tranches) of CDO securities.
First tranche covers x% of notional and absorbs first x% of default losses Second tranche covers y% of notional and absorbs next y% of default losses Etc. A tranche earns a promised yield on remaining principal in the tranche

Cash CDO Structure Illustration

Borrowers 10%

1000 b

Special Purpose Entity 10%

1000 b

Mortgage backed securities

Cash CDO Structure Illustration

Tranche 1 1st 5% of loss Yield = 35% Tranche 2 2nd 10% of loss Yield = 15% Tranche 3 3rd 10% of loss Yield = 7.5% Tranche 4 Residual loss Yield = 6%

Trust

CDO Life Cycle

Ramp-up period: Collateral portfolio is gathered and formed CDO manager representing the SPV purchases the collateral from loan originator (bank) Tranches are sold to investors

Cash-flow period: cash flow is distributed CDO manager can actively manage the portfolio Or the portfolio can be passively left unmanaged to generate cash flow
Unwind period: principal is repaid

Typical CDO
300 m Subordinated Notes/Equity 16.5 % 50 m

300 m

Mezzanine Fixed/Floating Rate Notes Senior Fixed/ Floating Rate Notes

7%

21 m

400 m

6%

24 m