Sunday, June 24, 2007

The What, How, and When of the CDO Market

The link to a Wall Street Journal article is a very good description of the what, how, and when of CDOs. It also includes an example starting with a single mortgage so it can be followed through the process. Good background information for the situation at Bear Stearns.

So what exactly are CDOs, the structures at the root of so much angst? They are financial vehicles that bundle different kinds of debt -- ranging from corporate bonds, to securities underpinned by mortgages, to debt backed by money owed on credit cards -- and cut it into slices. These slices are sold to investors in the form of bonds. While the slices contain the same debt, they differ in terms of which pay the most interest and which are least at risk of losing money.

. . . . The popularity of CDOs grew as low interest rates caused investors to embrace products that offered the promise of higher yields.

. . . . They also say that CDOs are another tool that allow financial markets to further spread risk so it isn't concentrated in the hands of a few players.

This WSJ link leads to a flowchart of the mortgage security process once the loan has been made.

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