Structured Products and Related Credit Derivatives: A Comprehensive Guide for Investors

CHAPTER 9

Basics of CDOs

Brian McManus

Senior CDO Analyst

Wachovia Capital Markets, LLC

Dave Preston, CFA

Associate CDO Analyst

Wachovia Capital Markets, LLC

Anik Ray

Associate CDO Analyst

Wachovia Capital Markets, LLC

Steven Todd, Ph.D.

CDO Analyst

Wachovia Capital Markets, LLC

Collateralized debt obligations, or CDOs, are an evolving and growing presence in today's capital markets. According to CreditFlux, the volume of outstanding cash CDOs stood at $986 billion at the start of 2007, and U.S. cash CDO issuance approached $400 billion in 2006.

While many investors still consider CDOs an esoteric asset class, CDOs have had a profound and far-reaching impact on global markets. Since 2003, CDOs have fueled two major market trends: (1) the growth of the private equity market—leveraged loans formed by leveraged buyouts (LBOs) that often reside in collateralized loan obligations (CLOs); and (2) the growth of the subprime mortgage market. In addition, CDOs have helped drive the rapid growth in the credit default swap (CDS) markets.

CDOs offer investors several advantages, including diversification opportunities, varying risk/return profiles, and exposure to asset classes that are often difficult to invest in directly. Investors should understand CDOs as a technology or a security structure, rather than as an asset class. As investments, CDOs' performance can vary greatly, depending on the collateral, the structure, the manager, and the specific CDO note's position in the capital structure. ...