5. TODAY
CDO + CDS, Definitions & Examples.
How do they relate to Ireland today?
6. Defini-
Securitization… is the process of packaging (illiquid)
liabilities and debt instruments, thus converting them
tion
into liquid tradable “asset-backed securities.”
7. BASIC STRUCTURE
The bank
The SPV
sells a
issues
portfolio of
bonds
loans
Special Purpose Investors
Bank
Vehicle
(SPV)
Payment for Proceeds
loan from the
portfolio issue
8. Central Bank policies (next week)
Interest rate policies and regimes.
Funding cost changes.
Exchange Rate policies.
Models, Pricing knowledge, fast and accurate
calculation of ‘Greeks’, Hedging ability
Leads to innovations in structured credit markets
9. What is a structured Credit asset ?
Reasons for using structured assets
Anatomy of a structured asset
CLE
CDO
Examples -- Pricing and sensitivity
10. A structured asset is, at the end… an asset
incorporating a derivative strategy.
But this notion gets broader in Credit
The notion of correlated events become central
11. Individual Credit Risk:
Credit Exposures by tranches
T
R Super
A
Portfolio Senior
N
of N Credit
C
Exposures AAA
H
To Be
I Mezzanines
Covered
N
Equity
G
12. A COLLATERALIZED DEBT OBLIGATION
(CDO) IS A STRUCTURED PRODUCT WHERE
A portfolio of securities is transferred to a SPV
SPV issues tranches of notes with different
seniority and there is also an equity stub
The CDO tranches are rated based on portfolio
credit quality, portfolio diversification, and
subordination.
Single tranche…bespoke CDO/CDO-squared
14. By reallocating the default probability CDO tranches
can generate returns of 15-20% from very small
default probabilities…
But, more importantly…
…they generate assets with different
sensitivities to (default) correlation
15. Buy Equity tranche…
…Sell Mezzanine tranche.
The effects of default probability will cancel out.
And the correlation effect can be isolated. This can
be traded.
16. Innovation is essential to make money
…and structured products are a major
way of doing this.
17. CDS
Credit default swap (CDS) market is a large and
fast-growing market that allows investors to trade
credit risk.
Credit default swap (CDS) is a contract between two
parties, where a protection buyer pays a premium to
the protection seller in exchange for a payment if a
credit event occurs to a reference entity. CDS are
customizable, over-the-counter products and can be
written to trigger in the event of bankruptcy, default,
failure to pay, restructuring, or any
other credit event of the reference entity.