Synthetic Collateralized Debt Obligation (Synthetic CDO)

The main difference between a synthetic CDO and a cash CDO lies in the fact that the bank holds a portion of the reference portfolio instead of selling it off to investors.  With a cash CDO, banks will transfer the risk to another party through the sale of the assets; however, in a synthetic CDO, banks will keep the assets on their balance sheet and purchase protection through a credit default swap to transfer the risk away to another party.

Structure of a Synthetic CDO

The structure of a synthetic CDO is setup where the bank owns the assets but transfers the risk to a pool of investors through a special purpose vehicle that they setup to act as the intermediary between th bank and the investors.  Essentially, the investors will contribute capital to the SPV in exchange for principal and interest payment from the underlying securities held by the bank.  In a fully funded synthetic CDO, the originating bank will fund the unfunded portion of capital required through an equity tranche.  For this reason, it is in banks best interest to pool the best assets together.  The equity tranche will be the last to receive funds in the event of a default. 

As the holder of assets, the bank will purchase credit default swap from the SPV.  This will insure their assets against loss and put the investors assets at risk in the event of a default. 

The video will illustrate how the bank will generate income from a few different streams.  Firstly, they will receive principal and interest payments on their securities from the SPV in the event of a default.  In this case, investors will lose.  They also own the SPV which will receive CDS premiums from the bank, investor capital, and they will also make interest on capital within the SPV.
Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...
Day Trading Simulator provides the ability to simulate day trading 24 hours a day from anywhere in the world. TradingSim provides tick by tick data for...

Send this article to a friend.

Enter multiple addresses on separate lines or separate them with commas.