Synthetic CDO that fails in subprime securitization

This illustrates a partially-funded synthetic CDO typical of the failed structure in the subprime meltdown. "Partially-funded" refers to the fact that only a fraction of the reference portfolio is collateralized (e.g., 7% to 15%); the investors purchase securities only on this funded tranche. "Synthetic" refers to the fact that credit risk is transferred not with a sale of loans to the SPE/SPV, but by the purchase of credit protection with credit default swaps (CDS).

Category:

Education

Tags:

• Finance
• Derivatives
• Subprime

[bionicturtledotcom]

default risk for a single obligor is not the cause of the complexity. The complexity in a CDO is securitization, credit risk transfer, and the structuring (tranching) of risk. It is not trivial to value/understand a tranched security that has dependence (attachment/detachments) to other pooled obligors and where you have layers of abstration.

[dajieda0]

very very good explanations. thank you!!!

[StataFanLearner]

How can I make a yellow circle around an arrow like you?

[shortloinsirloin]

Hello David - What software are you using to record your presentations?

Very well put together.

Thanks in advance

[rhunter187]

@Macgyver107 You nailed it!!! No one knows how to value these complex financial instruments. So much so, the Fed even chose not to try. They took the bailout money and chose to make equity injections instead of purchasing the toxic assets. So yes, all of the toxic assets still exist on bank balance sheets and nothing will change until these schemes are outlawed.

[rhunter187]

The originating banks should never need to purchase credit protection if they performed the proper due diligence on the reference portfolios in the first place. This is a complete scam and until securitizations and derivatives are outlawed, we the public will always be 'on the hook'. BTW, all of these toxic assets still exist on bank B/S's. So what's changed? Answer...NOTHING.

[covingtonium]

salman khan should do these so they are even better understood

[chekoutdude]

Hey David, its really helpin me gain knowledge abt des concepts.

Great goin.. Kudos to u!!!!

[jdkhanlian]

I never heard of the basis risk part of the SCDO story before. Why didn't they just structure that supersenior CDS as a single tranche SCDO if they wanted to completely remove the risk? I would just think that the crisis arrives just from the fact that the counterparty in the supersenior tranche CDS was also a bank and they didn't post collateral like the subordinate tranche investors did, making the whole SCDO partially funded.