Chapter 27 CAIA Flashcards - CDO Structuring of Credit Risk
Special Purpose Vehicle
A special purpose vehicle (SPV) is a legal entity at the heart of a CDO structure that is established to accomplish a specific transaction, such as holding the collateral portfolio. Usually, an SPV is set up as either a Delaware or a Massachusetts business trust or as a special purpose
Bankruptcy Remote
SPVs are often referred to as being bankruptcy remote. Bankruptcy remote means that if the sponsoring bank or money manager goes bankrupt, the CDO trust is not affected.
Diversity Score
A diversity score is a numerical estimation of the extent to which a portfolio is diversified. Portfolios of 100 securities can have substantially different levels of diversification, depending on the extent to which the securities are correlated.
The weighted average spread (WAS)
The weighted average spread (WAS) of a portfolio is a weighted average of the return spreads of the portfolio’s securities in which the weights are based on market values.
Cash Funded CDO
A cash-funded CDO involves the actual purchase of the portfolio of securities serving as the collateral for the trust and to be held in the trust.
Market Value CDO
In a market value CDO, the underlying portfolio is actively traded without a focus on cash flow matching of assets and liabilities.
Subordination
Subordination is the most common form of credit enhancement in a CDO transaction, and it flows from the structure of the CDO trust. It is an internal credit enhancement. Subordination is the process of protecting a given security (i.e., tranche) by issuing other securities that have a lower seniority to cash flows.
Overcollateralization
Overcollateralization refers to the excess of assets over a given liability or group of liabilities. Overcollateralization of a senior tranche occurs when there are subordinated tranches in a CDO.
Reserve Account
A reserve account holds excess cash in highly rated instruments, such as U.S. Treasury securities or high-grade commercial paper, to provide security to the debt holders of the CDO trust.
External Credit
An external credit enhancement is a protection to tranche investors that is provided by an outside third party, such as a form of insurance against defaults in the loan portfolio.
Collateralized Fund Obligation (CFO)
A collateralized fund obligation (CFO) applies the CDO structure concept to the ownership of hedge funds as the collateral pool.
Financial Engineering Risk
Financial engineering risk is potential loss attributable to securitization, structuring of cash flows, option exposures, and other applications of innovative financing devices.
Copula Approach
A copula approach to analyzing the credit risk of a CDO may be viewed like a simulation analysis of the effects of possible default rates on the cash flows to the CDO’s tranches and the values of the CDO’s tranches.
