Publications

The Evolution of the CDO Squared

Spring 2005
The Journal of Structured Finance

Much has been written about the structure of a collateralized debt obligation (or “CDO”) offering. In short, a CDO is an arbitrage vehicle that invests in a portfolio of financial assets—commercial loans, corporate or emerging market bonds, asset-backed securities, and trust preferred securities have been the predominant portfolios—that the CDO finances by issuing multiple tranches of senior and subordinated notes under an indenture and (often) issuing a “first loss” class of preference shares or income notes. A CDO is usually formed as a “bankruptcy remote” special-purpose vehicle in a tax-free jurisdiction (e.g., the Cayman Islands) or in a nominal taxjurisdiction (e.g., Ireland). In most cases a CDO will obtain ratings on the securities that it issues from Fitch, Moody’s, and/or Standard & Poor’s. Frequently, the CDO will retain an investment advisor, known as the collateral manager, to select and manage its portfolio. In some cases, it will enter into interest-rate hedges (usually under an ISDA master agreement) to mitigate the interest-rate mismatches between its assets and its liabilities.