Hello, in a synthetic CDO, junior tranches have the following income: (1) sell credit protection to receive the premiums (2) receive income from the high-quality securities However, what are the income sources for the senior tranches? Senior tranches buy credit protection through CDS and pay premiums. Please enlighten me. Thank you.
Hi, Senior tranches do get the small premium in return for the obligation to provide for any losses in case of default.
This thorough post by alex_k_21 may clarify things for you: http://www.analystforum.com/phorums/read.php?12,646463,646474#msg-646474
Thank you very much hiredguns1, it’s obvious that alex_k_21 is an expert on this. However, I still have problems in understanding: On page 434 of Level II 2009 CFA curriculum volumn 5, it says, “In a synthetic CDO, the insurance buyer is the asset manager…” “Who is the seller of the protection seller? It is the SPV on behalf of the junior note holders.” OK, literally it means (1) SPV on behalf of the junior tranches sell protection, hence receiving premium (understood) (2) Asset manager on behalf of seniour tranches buy protection (here’s my question: where is the money from to buy the protection?) hiredguns1 Wrote: ------------------------------------------------------- > This thorough post by alex_k_21 may clarify things > for you: > > http://www.analystforum.com/phorums/read.php?12,64 > 6463,646474#msg-646474
you need to keep in mind that the assets and the liabilities of the CDO need to match. for instance, lets assume the reference portfolio is $100m of corporate credits. on the asset side, the SPV will sell insurance on this reference portfolio and receive premium based on the $100m notional. on the liability side, the SPV will issue notes (super senior, funded notes, and equity). the total notional of this capital structure will be $100m if we disregard closing costs. in your example, it is a hybrid structure where the proceeds from the funded notes is invested into high quality collateral. the funded notes will receive LIBOR (from collateral) + spread (from premium). the unfunded super senior will receive a commitment fee (from premium) the equity will receive any excess spread (a performing portfolio will generate more premiums than necessary to service the spread payments to the funded notes + the super senior commitment fee)
Thank you ShouldbeWorking. Is there any literature on this I can read?
try this. the report is quite dated (2004) but the concepts are still relevant http://www.vinodkothari.com/Nomura_cdo_plainenglish.pdf
Thanks for sharing ShouldBeWorking. It’s very good.