Credit Derivatives Harvard Case Solution & Analysis

COLLATERALIZED DEBT OBLIGATION

A portfolio comprised of assets such as a combination of bonds, securitized receivables, asset-backed securities, and tranches of other collateralized debt obligation backing up a single debt is called a Collateralized debt obligation.

Some specialist dictates that Collateralized debt obligation is comprised of only bonds and loans in a portfolio backing up the debt, but generally it is referred as an umbrella which provides securitization of assets.

Special purpose vehicles or special purpose entities till the end of 1990’swere used under the collateralized debt obligations, these entities would purchase and acquire a portfolio of assets and would also be issuing debt, but most likely they purchase assets that are registered by the bank and are presented on their balance sheets. These vehicles are labeled as bankruptcy remote making these delinked, means they nothing to do with the bank arranger’s credit risk who is also called the originator. The rewards that the originator  receives are administration fees and hedging fees and also servicing fees these are earned from the Special purpose vehicles, but these have no effect on the cash flows of the Special purpose vehicle assets.

It was the duty of the investment banks and other banks to provide collateralized debt obligation tranches to be able to provide the necessary funding which would be creating bridge financing, this finance is mostly used for the acquisition of the portfolio assets which were used to tranches.

In the modern era the use of the special purpose entity has been replaced with synthetic securitizations this has eliminated the requirement and use of the special purpose entity, but every now and then the special purpose entity may be used to issue notes having limited recourse which is linked to the linked collateralized debt obligation.

Credit Enhancement

There are a variety of forms that shows credit enhancements, and many of the credit enhancements are formatted in just one transaction. The most commonly used credit enhancements are as follows,

À      Initial overcollateralization

À      Subordination as a valuable piece

À      Junior banks to the securitization vehicle

À      Credit wraps

À      Security bonds

À      Government certifications

À      Reserving records of overabundance coupon spread not needed for quick installation of liabilities.

À      Reserving records of overabundance money

À      Credit subordinates

À      Cash stream redirection once pre-specified conditions or triggers are met

Channels may utilize letters of credit (LOC’s) and liquidity lines to guarantee money stream prerequisites, and may additionally add a paw back LOC to secure against installments being renamed as particular in the occasion of liquidation. A few years back, Locks were a typical manifestation of credit improvement for Visa securitizations.

As of late, a structure asked me what happened to all the LOC’s, where they excessively costly? It isn't that the expense is restrictive – despite the fact that it may get to be restricted under BIS II- yet rather that a LOC has less esteem as credit upgrade, on the grounds that such a large number of banks had been minimized.

The most astounding rating conceivable on a wrapped tranche is the rating of the credit wrap supplier. The measure of credit upgrade relies on upon the arrangement structure. The measure of improvement is communicated as several of the normal misfortune level. Case in point, to get an AAA rating, a general standard is that the credit improvement................

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