22 - Synthetic Collateralised Debt Obligations

Abstract

This chapter focuses on the development of synthetic collateralized debt obligations (CDOs), which are the structures that use credit derivatives in their construction. Cash flow CDOs are similar to asset-backed securitizations involving a special purpose vehicle (SPV). Arbitrage CDOs are classified into either cash flow CDOs or market value CDOs. A cash flow arbitrage CDO has certain similarities with a balance sheet CDO, and if it is a static pool CDO, it is also conceptually similar to an asset-backed security (ABS) deal. The ongoing development of securitization technology has resulted in more complex structures, illustrated perfectly by the synthetic CDO. Differences between synthetic and cash CDOs are best reflected in the different cost–benefit economics of issuing each type. The return analysis for CDOs performed by potential investors is necessarily different from that undertaken for other securitized asset classes. The factors that may explain the difference in yields include the perception of the asset manager, secondary market liquidity, and the placing power of the arranger of the transaction.