A CDO is a securitised debt obligations which always allow the investor to gain good number of exposures to an underlying and diversified pool of assets. However it is a very big and diversified category and hence could include many more diversified product. For example a CDO also help to collect loans and mortgages towards ensuring product security. However the CDO follows the same aspect and comes in many flavours to address the investor needs. There are many different trenches to this process which allows the investors to vary their risks and return profile which is basically known as the “waterfall cash flow structure “or they could be used in a single trench. The CDO can be of two types like cash and synthetic. The cash CDO are the actual assets such as bond, loan and other derivative products such as default swaps ,options etc. for example default swaps are basic derivative products which are generally been used in insurance credit fields on the other hand the insurance credit roles also play an important part in the financial crisis. The structure of it is far more complex and are meant that the single and isolated pool of assets could add a single number of contracts on them by making single number of cash or money beating on them. Considering an example in this regard that synthetic CDO could give exposures to a pool of CDO which does depend on the underlying pool of assets. It also depend upon the credit quality of the insured, potentially mortgaged, loan, banks and the other pool of assets. Thus it is seen that the things get totally complicated at each and every level and hence it is literally tough for the investors to know about every exposures at each stage. Thus a single pool of mortgages worth of 1 billion GBP has been beaten due to the use of other instruments.
On the eve of securitization of CDO, every critics on the products and the banks will be put all together in a single phrase. Hence before getting into the main stream it is important to go into some of the primary reasons to introduce the products and solve the problems initially. Firstly securitization on the mortgages will be imagined to solve a very real time problems to this aspects. Every single mortgage banks underwrote the mortgage part of in the banks balance sheet, limiting the banks further credit ability. Thus the banks mortgages off the balance sheet into a SPV and also settles of the CDO or MBS securities. Thus if they keep on providing the service on a continuous basis , then more risks will be involved in this case and the investors will withdraw their investments. On the other hand there are some investors who could likely get restricted by the rules and regulations over the recklessness of investments they could make. They can only investment over securities with highest returns and hence these are rated as high quality investors. However the banks had begun to move their mortgages into SPV by selling of their CDO. Hence they had been able to continue to serve the public by extending the mortgage value and thus by increasing the risk of the mortgages which had been taken up by the investors. However there are also a special kind of investors who had been restricted to the obligation on recklessness of investments which they could make. The individual debt instruments have the highest security value and thus they had imposed a good number of difficulties to the instruments. However for any investor these kind of instruments are need to be made and thus they need to make the most out of it. Since the loans and mortgages are not been properly rated, as by introducing the waterfall cash structure model, the most secured trenches are been highly rated and pension funds get instrument exposures.. Furthermore the CDO also allows the banks to restructure the loan packages over other asset securities .it happens because the waterfall cash flow model implies a very high range of underlying loans which is need to default before the senior tranches appeared. Similarly for the risky investment funds such as all the hedge funds or looking to invest to a higher pay-out ratio. However the banks always try to make ratio with the CDO and other number of ways. These are as follows-
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