Cash CDO

A cash CDO is one in which a vehicle is established to acquire a portfolio of individual debt exposures and issue liabilities of differing seniorities which are therefore collateralised by the debt exposures.

Cash CDOs differ from

synthetic CDOs in that they own physical (cash) debt securities rather than taking on credit exposure using credit default swaps. The growth of the asset-backed credit default swap market has blurred the boundary between cash and synthetic CDOs, since many CDOs of ABS now take on risk through both cash bonds and credit derivatives.

The most common collateral for cash CDOs are currently high yield loans and asset-backed securities. Those backed by high yield corporate bonds, investment grade corporate bonds, real estate investments, trust preferred securities and emerging market bonds are also seen.

Cash CDOs usually have two feature that distinguish them from other forms of securitisation. They typically employ an investment manager (asset manager or CDO manager) to select the initial collateral, and buy and sell assets during the life of the deal.

They also usually include provisions to divert income to pay down the CDO’s liabilities in descending order of seniority in certain circumstances. These provisions, the

overcollateralisation test and the interest coverage test, are designed to protect the most senior notes from suffering any losses.

See also

cashflow CDO.