By Douglas J. Lucas

Due to the fact first edition's booklet, the CDO industry has visible great progress. As of 2005, $1.1 trillion of CDOs have been notable -- making them the fastest-growing funding automobile of the decade. that can assist you stay alongside of this increasing marketplace and its a number of tools, Douglas Lucas, Laurie Goodman, and Frank Fabozzi have collaborated to convey you this absolutely revised and up to date new version of Collateralized Debt duties. Written in a transparent and available kind, this invaluable source presents serious information about the evolving nature of the CDO industry. you can find in-depth insights gleaned from years of funding and credits adventure in addition to the exam of quite a lot of concerns, together with money CDOs, loans and CLOs, dependent finance CDOs and collateral assessment, rising industry and industry price CDOs, and artificial CDOs. Use this e-book as your consultant and make the most of this dynamic industry and its items.

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Extra resources for Collateralized Debt Obligations: Structures and Analysis, 2nd Edition (Wiley Finance)

Example text

4 shows actual average cumulative default rates from 1 to 10 years based on Moody’s data from 1983 to 2004. 20% after 10 years. 43% after 10 years. Generally, as would be expected, bonds with lower ratings exhibit higher default patterns. Moreover, defaults rise exponentially, not linearly, as rating decline. However, it is difficult to use these data to construct a stylized default pattern, as some anomalies appear. For example, over some time periods, Aaa bonds default more frequently than do Aa1 bonds.

Distribution of collateral cash flow amongst tranches in a CDO is a zero-sum game. And since equity receives residual cash flow after debt tranches are satisfied, PIK-ing and the diversion of cash flows to Class A principal affects it the most. First, the CDO’s average cost of funds increases. Second, the CDO becomes more delevered. Finally, less cash reaches the equity tranche, and that which does is delayed. Quality Tests After the tranches of a CDO deal are rated, the rating agencies are concerned that the composition of the collateral portfolio may be adversely altered by the asset manager over time.

Interest payments are allocated first to high priority deal expenses such as fees, taxes, and registration, as well as monies owed to the asset manager and hedge counterparties. After these are satisfied, investors are paid in a fairly straightforward manner, with the more senior bonds paid off first, followed by the subordinate bonds, and then the equity classes. Note the important role in the waterfall played by what is referred to as the coverage tests. We will explain these shortly. They are important because before any payments are made on Class B or Class C bonds, coverage tests are run to assure the deal is performing within guidelines.

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