Considerations for dynamic and static, cash and synthetic collateralised debt obligations

By Alexander Batchvarov, Jenna Collins and William Davies

This article was first published as a chapter in Credit Derivatives, by Risk Books.

European collateralised debt obligations (CDOs) have evolved from early, static, balance-sheet cash transactions to utilise synthetic execution, synthetic assets and various dynamic forms of credit portfolio management. As the market continues to evolve, diversification takes on new dimensions, potential volatility and complexity of excess cash flow may increase, currency risk is more dynamic, liquidity needs often become more significant, losses may crystallise due to trading behaviour rather than simply credit risk, obligation settlement and valuation requires careful definition, and management flexibility and/or investor input often increases. Although the market often refers to CDOs as existing in one form versus another – static or managed, cash or synthetic – clear distinctions in nomenclature have diminished in practice, and the increasing degree of variety within the market necessitates new questions from CDO investors.

CDO MARKET ROADMAP

CDOs have established themselves in the market as a distinct sector, and one can argue that the sector has matured, given that it went through severe

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