Collateralized debt obligation (Balance Sheet CDO)

A balance sheet CDO transfers credit risk from the bank (originator) to investors. A key aspect of a CDO is that investors have different (tranched) securities.

Category:

Education

Tags:

• Finance
• Excel
• Quant

[FinancialEngineer]

May I ask how did you learn all of this?

[bionicturtledotcom]

I teach/learn FRM (risk) at my site, bionicturtle. I was a consultant for many years, but i do a lot of self study via CFA & FRM.

[bionicturtledotcom]

Hi KLguy133, absolutely many of the investors were banks holding/retaining the "high rated" tranches. In dollar terms, I'd bet more has (so far) been lost on drops in value in these tranches than defaults at the lower level.

[bionicturtledotcom]

Thanks David, I really appreciate that. I haven't seen the lender-of-last-resort data and am a little unclear how that gets them stuck. But to your latter, clearly much of the absolute losses are due to banks retaining the (unfunded) super senior paper (the highest rated tranches). Then two problems: 1. just valuation plummet, way more sensitive to lower tranches than modeled, and 2. the CDS HEDGES on these "safe" securities did not work (basis risk big time). Thanks! Dave

[dajieda0]

my lecturer did really did a good job on this topic...

[dajieda0]

@austinacmes you are right. Thanks.

[dajieda0]

why senior tranches like low correlation assets while subordinate tranches prefer high correlation?

[donttrythis55]

why does the bank originator keep equity on it's balance sheet? I understand the different tranches but what do you mean by equity? When you have excess spread does that mean the purchase price less principal and interest? Thanks

[PionnerDU]

Hi there It would be so grat and helpfull to add the chapter to the title since you are using John Hull... many student are having hard time understanding some of these chapter so it will be great if you have that.

Thank You so much your video help me alot but sometimes it is so hard to find some of the stuff..that relate to the chapter.

I will be very soon one of your student

[austinacmes]

@dayzman It is because subordinated tranches are the first ones to absorb the losses of the portfolio. Low default correlation among the assets means over a period of time, one or two names default won't pull the whole portfolio under water. Therefore, the sub tranches will always be the first ones to absorb these losses. The senior tranche, however, with a low default correlation among the assets, can use these sub tranches as cushions. The reverse is true when the default correlation is high.

[dayzman]

@austinacmes I wonder about this too. Anyone?

[austinacmes]

Hi David, great video. I have a question while watching this video. hope you don't mind answering. Why would a low default correlation among the originator's assets will hurt the subordinated tranches?