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Collateralized Debt Obligations and Structured Finance: New Developments in Cash and Synthetic Securitization

ISBN: 978-0-471-48136-2
352 pages
March 2004
Collateralized Debt Obligations and Structured Finance: New Developments in Cash and Synthetic Securitization (047148136X) cover image


The most cutting-edge read on CDO and credit market structures
Collateralized Debt Obligations and Structured Finance provides a state-of-the-art look at the exploding CDO and structured credit products market. Financial expert Janet Tavakoli examines securitization topics never before seen in print, including the huge increase in the CDO arbitrage created by synthetics; the tranches most at risk from this new technology; dumping securitizations on bank balance sheets; the abuse of offshore vehicles by companies such as Enron; and securitizations made possible by new securitization techniques and the introduction of the Euro. This valuable guide comprehensively covers one of the fastest growing markets on Wall Street, predicting where new bank regulations and other developments may lead to product growth or product extinction. While providing an overview of the market and its dynamic growth, Collateralized Debt Obligations and Structured Finance explores the types of products offered, hedging techniques, and valuation and risk/return issues associated with investment in CDOs and synthetic CDOs.
Janet M. Tavakoli, MBA (Chicago, IL), has over eighteen years of experience trading, structuring, and marketing derivatives and structured products with major financial institutions in New York and London. She is also the author of Credit Derivatives and Synthetic Structures, now in its Second Edition (0-471-41266-X).
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Table of Contents


CHAPTER 1: The CDO Paradigm Shift.

Estimated Market Size.

CHAPTER 2: The Origins of Securitization.

The CDO “Arbitrage”.

Portfolio Diversification and Credit Events.


True Sale, Hybrid, and Synthetic Structures.

Credit Enhancement.

CDO Classifications.

Market Value CDOs.

Cash Flow CDOs.

The Origins of U.S. Securitization.

Collateralized Mortgage Obligations.

CHAPTER 3: Structured Finance and Special Purpose Entities.

SPCs and Historical Abuse.

SPEs and SPVs.


Example of a Multiple Issuance Entity (MIE).

Cayman Domiciled SPEs.

Repackagings to Satisfy Investor Demand.

CLNs and Funding Costs.

Structured Floaters.

Principal Protected Notes (PPNs).

Loan Repackagings.

Mismatched Maturities.


Setup Costs.

Unwind Triggers Linked to Derivatives Transactions.

DAX-Linke d Note with Triggers.


Master Trusts.

Owner Trusts.

Grantor Trusts.


Multiseller and Single Seller Conduits.

Domestically Domiciled Corporations.

Bankruptcy Remote?

CHAPTER 4: Credit Derivatives and Total Rate of Return Swaps.

Risks to Portfolio Value.


Are You Hedged?—The Regulatory Viewpoint.

Digital Cash Payment—Alternate Termination Payment.

Initial Value _ (Par _ Market Value): Alternate Termination Payment.

Normalized Price Method—Alternate Termination Payment.

Hedge Costs in Cash and Synthetic CDOs.

Deliverables: CDOs and the “Cheapest to Deliver” Option.

Convertible Bonds and Asset Swaps.

Default and Recovery Rate.

The Default Protection Seller: Credit and Correlation.

Default Language for Sovereign Debt.

Default Language for Nonsovereign Debt: Controversy and CDOs.

Comments on CDS Prices.

Total Rate of Return Swaps (Total Return Swaps).

Pricing TRORS on Levered CDO Tranches.

TRORS versus Repos.

Moral Hazard with Bank Loan Reference Assets.

CDS versus TRORS.

CHAPTER 5: Cash versus Synthetic Arbitrage CDOs.

Comparison of Managed Arbitrage CDO Features: Cash versus Synthetic Deals.

The Arranger and the Manager.

Mandate Agreement.

Deal Assembly.

CDS Language for the Synthetic CDO.

Selecting the Portfolio and Impact on Rating.

Rating Criteria and Restrictions.

Substitution and Reinvestment Criteria.

Warehousing Assets.

Pricing and Closing.

Ramping-Up the Portfolio.

Reinvestment Period.

Non-Call Period.

Pay Down Period.

Weighted Average Life and Expected Final Maturity.

Early Termination.

Legal Final Maturity.

Tranching and the Synthetic Arbitrage Advantage.

Waterfalls for Cash versus Synthetic Arbitrage CDOs.

Payment-in-Kind (PIK) Tranches.

Psychic Ratings: Rating Agency Treatment of PIK Tranches.

The Super Senior Advantage.

CDS versus Cash Asset Spreads.

Simplified Examples of Interest Rate Swaps and Asset Swaps.

Hedging the CDO Portfolio Cash Flows.

Settlement in the Event of Default or Credit Event.


Cash versus Synthetic Arbitrage CDO Equity Cash Flows.

Sample Cash Flows.

Summary of Cash Arbitrage CDOs versus Synthetic Arbitrage CDOs.

CHAPTER 6: Cash Flow Caveats.

Conventional Wisdom.

Accruing Errors.

Probability of Receipt.

Equity Structures.

Equity Earns all Residuals, But Loss Is Limited to Original Investment.

Equity Investor Injects Cash as Overcollateralization.

Rated Equity Earns Stated Coupon Appropriate to Rating.

Rated Equity: Static Deal.

Equity Investor Earns a Stated Coupon on the Remaining Equity Investment.

Conflict of Interest between the Residual Holder and Senior Tranche Investors.

Unfunded Equity Investments—Ultimate Leverage.

Actively Traded and Limited Substitution Synthetic Arbitrage CDOs.

Interest Subparticipations (ISPs): When Equity Isn’t First Loss.

Participation Notes (PNs).

Capped PNs.

Combination Notes (CNs).

Investor Motivation.

Principal Protected Structures.

CHAPTER 7: Balance Sheet CDOs.

True Sale (“Fully Funded”): Delinked Structure.

Linked Nonsynthetic Structures.

Linked Black Box Credit Linked Note (CLN) CDOs.

Synthetic Structure with SPE (BISTRO).

Partially Synthetic Linked CDOs.

Fully Synthetic CDOs.

Small to Medium-Size Enterprises (SMEs)—Europe.

SMEs: United States versus Europe.

Secured Loan Trusts.

Regulatory Capital—The Model Advantage.

Regulatory Capital—BIS II.

CHAPTER 8: Structured Finance and Risk.

Credit Risk Dumping Grounds: The Bank’s Balance Sheet and Trading Books.

Loans and Other Exposures.

New Structured Finance Deals.


Enron, J.P. Morgan, and Offshore Vehicles.

Participation Notes.

Equity Total Rate of Return Swaps (TRORS)—Loans Disguised as Capital Injections.

The Trading Book Parking Lot: Regulatory Capital Arbitrage.

Trading Books and CDOs: Short Mezzanine and Long Equity.

Hedge Funds as Investors.

Structured Finance and Accounting (Kidder Peabody).

The Sarbanes-Oxley Act of 2002.

Will Sarbanes-Oxley Make a Difference?

CHAPTER 9: Super Senior Sophistry.

The AAA Rip-Off.

Rating Agencies—Moody’s Tranching.

AAA Basket with 2 Percent First-Loss Tranche.

Super Senior Attachment Point.

Super Senior Pricing.

Super Seniors or Senile Seniors?

Where Are the Regulators?

Junior Super Seniors.

Super Senior “Investors”.

Final Thoughts on Super Seniors.

CHAPTER 10: Selected Structured Finance Products.

Future Flows: Payment Rights Securitizations.

Emerging Market Caveats 298

Multisector CDOs: CDOs2.

Structured Investment Vehicles (SIVs): Credit Arbitrage Funds.

Hedge Funds and Collateralized Fund Obligations (CFOs).

First (and nth)-to-Default Basket Swaps.

Portfolio Swaps.

Multiline Insurance Products: Disappointment and Promise.

Lexington (AIG) and Hollywood Funding.


CHAPTER 11: Future Developments in Structured Finance.

Playing the Game with BIS II.

Trend to Risk Distribution.

Acronym Key.

Selected Bibliography.

Interesting Web Sites.


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Author Information

JANET M. TAVAKOLI is the President of Tavakoli Structured Finance, Inc. (www.tavakolistructuredfinance.com). Tavakoli has over eighteen years of experience trading, structuring, and marketing derivatives and structured products with major financial institutions in New York and London. She is a former Adjunct Associate Professor in the Finance Department of the University of Chicago’s Graduate School of Business where she taught Derivatives. Tavakoli is also the former Executive Director and Head of Financial Engineering for the Global Capital Markets Group of WestLB in London.
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“…Tavakoli uses her broad professional experience to examine the CDO market in simple and clear language.” (Risk, March 2004)

"Tavakoli…does what she can to address this market’s growing pains in…this intriguing book" (Hedge World)

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