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Synthetic CDO
A synthetic collateralised debt obligation is a derivative created from the securitization of a portfolio of credit default swaps. as opposed to the securitization of cash assets such as bonds or loans.
sold by a financial institution party to a special purpose vehicle (SPV). The SPV issues securities collateralised by the portfolio of bonds or loans.
See also: Derivatives, http://www.federalreserve.gov/Pubs/feds/2004/200436/200436pap.pdf
A form of collateralized debt obligation (CDO) that invests in credit default swaps (CDSs) or other non-cash assets to gain exposure to a portfolio of fixed income assets. Synthetic CDOs are typically divided into credit tranches based on the level of credit risk assumed. Initial investments into the CDO are made by the lower tranches, while the senior tranches may not have to make an initial investment.
All tranches will receive periodic payments based on the cash flows from the credit default swaps. If a credit event occurs in the fixed income portfolio, the synthetic CDO and its investors become responsible for the losses, starting from the lowest rated tranches and working its way up.
CDO in which the underlying credit exposures are taken on using a credit default swap rather than by having a vehicle buy physical assets. Synthetic CDOs can either be single tranche CDOs or fully distributed CDOs. Synthetic CDOs are also commonly divided into balance sheet and arbitrage CDOs, although it is often impossible to distinguish in practice between the two types.