of Credit Derivatives
Derivatives: Market Info and awareness
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A synthetic CDO in terms of structure is no different from a usual collateralized debt obligation (CDO). A CDO is a device whereby a portfolio of loans or other debt obligations are transferred to a vehicle (the CDO SPV) which raises liabilities to finance such assets, in a manner that the repayment of the liabilities is solely collateralized by the portfolio of loans or debts. In other words, a CDO is a process of securitising a portfolio of loans or debt obligations.
CDOs are the fastest growing segment of the securitisation market - for more on CDOs, see the CDO page on Vinod Kothari's securitisation site
CDOs are classed into cash or synthetic CDOs, based on the nature of their assets. If the assets are acquired for cash, the CDO is a cash CDO. However, if the CDO acquires primarily synthetic assets by selling protection rather than buying assets for cash, it is a synthetic CDO.
Evidently, the amount of funding required for a synthetic CDO is much lesser than that of a cash CDO. The amount of cash raised is limited only to the extent of expected and unexpected losses in the portfolio of synthetic assets, such that the highest of the cash liabilities can get a AAA rating. Once a AAA-rating is obtained for the senior-most cash liability, a synthetic CDO does not raise more cash - it merely raises a synthetic "liability" by buying protection from a super-senior swap provider.
Vinod Kothari's book Credit Derivatives and Synthetic Securitisation discusses the synthetic CDO device threadbare with several case studies.