In light of recent developments involving SEC and Goldman Sachs, I reckon it might he extremely helpful for my readers to witness the entire structuring process involving a High Grade Asset-Backed Securities Collateralized Debt Obligations (HG ABS CDO) deal. For the sake of simplicity, let’s assume that our CDO transaction is labeled “Pyramid”, and the three stakeholders involved in this deal are: an investment bank – the “Arranger”, a portfolio manager – the “Collateral Manager” and a series of investors. To make things easier, I would replicate the same numbers from the previous two articles on structuring and securitization. The CDO liability bonds – the “Notes” will be issued by a newly formed Special Purpose Vehicle (SPV) – the “Issuer”, called Pyramid Limited and incorporated in Cayman Islands for tax purpose. Continue reading ‘Weapons Of Mass Destruction (III)’
Archive for the 'Capital Markets Products' Category
As we recall, the credit markets had an exceptionally difficult year in 2008, when risk appetite declined, prices collapsed and yields rose dramatically. High-yield, or junk, debt is rated below Baa3 by Moody’s and lower than BBB- by Standard & Poor’s. These days, Goldman Sachs is recommending staying investing in high-yield corporate bonds, especially BB and B bonds, and taking profits in the CCC papers. Over the last 12 months, BB bonds have returned over 39 percent, underperforming the CCC tier by 66 percentage points. The Merrill Lynch US High Yield Master II index gained almost 5 percent this year, following a 57.5 percent return in 2009 while debt graded in the CCC tier and below has more than doubled in the past year. Leveraged loan prices climbed to 91.9 cents on the dollar, the highest since June 2008, while the CDX HY BB Index, a credit-default-swaps benchmark for 34 BB-rated US corporations, rose to $108.20. Continue reading ‘Back Into Junk Bonds’
A currency carry trade is defined as a leveraged cross-currency position built-upon an interest rate differential that is targeted to higher expected risk-reward transactions. The aforementioned trading strategy consists of borrowing low interest currency capital and investing in currencies with higher interest rates. Alternatively, the borrowed currency capital could be invested in various classes of assets with a superior perceived return. Normally, carry trades would be limited opportunities, as long as the markets react efficiently and quickly close the existing window of arbitrage. However, carry trade strategy does violate one of the fundamental theories that govern the foreign exchange market: the uncovered interest rate parity (UIP). According to the theory, UIP states that the expected change in the spot rate must reflect the interest differential between two currencies. The same theory predicts that the country with the high interest rate will witness its currency depreciate. Continue reading ‘USD Carry Trade’
Now, that the picture of MBS has become crystal-clear, we will move to the next level: the Collateralized Debt Obligations (CDO). These structured products are nothing more than a redistribution of credit risk, similar to the way MBS are constructed. If the assets purchased for cooking-up MBS were residential mortgage loans, when structuring CDO deals the pool of assets consists of MBS. Depending on the average credit rating of the MBS, we could structure a High Grade Asset Backed Securities CDO (HG ABS CDO) or a Mezzanine ABS CDO. In a typical HG ABS CDO, we could purchase a $1 billion collateral portfolio of MBS bonds with a weighted average coupon of LIBOR plus 80 basis points. Continue reading ‘Weapons of Mass Destruction (II)’
In a 2002 speech referring to credit derivatives, Alan Greenspan – the former FED chairman and one of the most illustrious minds I have ever come across, said that financial instruments such as credit default swaps (CDS) and collateralized debt obligations (CDO) have helped make the economy shock-resistant: “Such instruments appear to have effectively spread losses from defaults by Enron, Global Crossing or WorldCom”. If Greenspan, with a heavy background in math, could not understand the complexities of CDO, all the less so the unsophisticated investors could not assess the risk embedded in these esoteric securities. My ultimate goal is educating my readers and removing the black-box label from these securities once for all. To get to our Omega destination, we have to start at the Alpha point. Continue reading ‘Weapons of Mass Destruction (I)’
CDS – The Usual Suspect
Credit Default Swaps (CDS) are plain-vanilla financial contracts that allow hedging a credit exposure or betting on whether or not an underlying credit instrument (e.g., a bond, a loan) does experience a specified credit event (typically a default) within a given period of time. In plain English, the CDS buyers make money if the underlying credit name does default, whereas the CDS sellers pocket the profit otherwise. With a total notional amount exceeding $60 trillion, the credit derivatives market has gained notoriety over the last ten years but it quickly became the scapegoat for the subprime debacle, Lehman Brothers bankruptcy and the collapse of the insurance giant AIG. Nevertheless, the CDS market is back on top again, sending shockwaves in the credit world and making it harder for troubled companies or debt-strapped countries to borrow money. Continue reading ‘CDS – The Usual Suspect’