The paper "CDO’ s Current Practice and Controversies" is a great example of finance and accounting coursework. Credit derivative financing has become a global phenomenon as it allows the occurrence of financial transactions in which the value of a transaction lies in the risk likelihood based on the mortgage of bonds, financial certificates or another financial asset. The transaction done on the basis of such financing is always based on the credit risk which is dependant upon something other than the dealing entities not on the transaction itself. There are multiple methods involved in credit derivative financing.
Moreover, credit derivatives are a legal source of credit generation and support the economy of certain countries. It has been defined by Edmond Parker (2008): “ Credit derivatives are bilateral contracts between a buyer and seller under which the seller sells protection against the credit risk of the reference entity” . In credit derivatives, the parties transacting decide the terms and conditions for the deal before signing. The conditions that are mostly decided in credit transactions involve the possible risks like the inability to pay the credit, bankrupt, breaching of the agreement signed.
Moreover, in case of a risk that a requirement of the reference entity will be required to gather pace, the bond will be declared instantly payable subsequent a default. Other risks like negation/freeze and restructuring (reforming) are also decided by the two parties before signing a deal. Collateralized Debt Obligations (CDOs) is a credit derivative instrument which is becoming popular in the modern era. This is because of the fact that Collateralized Debt Obligations has become a major gizmo in financial banking to avoid the credit risk experience as compare to the other mortgage-bundling instruments.
CDOs are basically, the type of mortgage in which security is granted to the investor on behalf of a fixed value asset. In this type of credit derivative, the tranches are used. The tranches are a similar kind of securities (security certificates) of different risk levels. These tranches are senior and junior, according to the seniority of the security and its class, preference for it varies. Interest and the major payments are made to the investors according to the order of precedence. The low-grade tranches present some coupon payments and sometimes low-interest rates.
It can also provide lower prices to pay off default risk in investments. On the other hand, senior security is provided with grand payments. The investment banks usually issue the CDOs in order to earn a commission at the time of delivering and later on get management fees during the verve of the CDO. The power of earning significant fees lies in the services like creating and making loan secure, together with the absence of any outstanding liability and in tilting the incentives of originators in favor of loan volume rather than loan quality. Sometimes CDOs are created out of other CDOs.
Generating the CDOs from other CDOs may produce massive problems in accounting, letting the large financial institutions to exclude debt off their books by grouping their liabilities with other financial organizations and getting these debts back on to their books again making it a Synthetic CDO asset afterwards. Creation of CDOs from other CDOs has permitted monetary institutions to conceal their losses but has made them able to increase their income.
‘CDO and risk management’, available at: http://phorgyphynance.wordpress.com/2007/07/10/cdos-and-risk-management/
An Introduction to CDOs and Standard & Poor's Global CDO Ratings, Available at: http://www.taiwanratings.com/en/criteria/CDO.asp?category=Criteria
(Celent, 2005-10-31). "Collateralized Debt Obligations Market". Press release. http://www.celent.com/PressReleases/20051031/CDOMarket.htm. Retrieved 2009-02-23.)
DeBenedictus, M. (2008), ‘Technology's Role in Restoring The CDO Market’,
Publication: Mortgage Banking, available at: http://www.allbusiness.com/banking-finance/banking-lending-credit-services/11736625-1.html.
Dr Steve Keen report summary included in article “Unsustainable debt: Australia’s own subprime crisis”, Published Tuesday, 18th September, 2007. available at: http://cpd.org.au/mediarelease/australias-own-subprime-crisis
Gibson, M. S. (2004), Understanding the risk of synthetic CDOs, available at: http://ideas.repec.org/p/fip/fedgfe/2004-36.html
History of CDO’s, available at: http://www.oscn.net/applications/oscn/deliverdocument.asp?citeid=433720 Located in footnote of court document
Jobst, A. A. (2003), ‘Asset-backed securitisation--motivation and advantages of collateralised debt obligations (CDOs)’, Publication: The Securitization Conduit, available at: http://www.allbusiness.com/finance/551175-1.html
Laurent, J. (2007), ‘A Note on the Risk Management of CDO’, available at: http://www.defaultrisk.com/pp_crdrv133.htm
Parker, E. (2008), available at: http://www.mayerbrown.com/london/article.asp?id=4234&nid=1575. Accessed on: 24th September, 09.
Steve Keen is Associate Professor of Economics & Finance at the University of Western Sydney and a fellow of the Centre for Policy Development. Copies of the paper are available on request from the Centre for Policy Development - or download it from http://cpd.org.au/paper/deeper-debt
West, M. (2008), ‘Local government lottery’, business day on November 17, 2008. Available at: http://www.smh.com.au/business/local-government-lottery-20081117-688i.html