Structured Finance and Collateralized Debt Obligations : New Developments in Cash and Synthetic Securitization

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  • Edition: 2nd
  • Format: Hardcover
  • Copyright: 2008-09-16
  • Publisher: Wiley
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Praise for Structured Finance & Collateralized Debt Obligations Second Edition"Janet Tavakoli warned the world this disaster was coming well in advance. Now she explains it again for those who did not listen before as well as why it is not over yet. You need to read this book to understand the biggest credit bubble in world history." --Jim Rogers, author of A Bull in China, Hot Commodities, Adventure Capitalist, and Investment Biker"Janet Tavakoli's new book provides an insider view into the opaque world of structured finance and collateralized debt obligations. With its clear explanations of numerous structured-finance innovations, I expect this book to become the 'Rosetta Stone' for deciphering these markets. This book is a service to the investment community." --Hilary Till, Cofounder, Premia Capital Management, LLC"Janet Tavakoli explains the complex world of structured finance with unusual flair and colorful anecdotes from securitization's front lines. An indispensable and up-to-date guide for anyone seeking greater understanding of the CDO market." --Charles C. Henneman, CFA, Head, Educational Programs and Events, CFA Institute"Janet Tavakoli has been able to dissect, with a brisk style, the intricacies of many structured products. Not only does she explain in a clear and insightful manner how certain things work, but more important, why others do not work!" --Arturo Cifuentes, PhD, Managing Director, R.W. Pressprich & Co."Stan O'Neal, Marcus Ospel, and more than a few other bold-face names in finance might still have jobs if they'd taken the trouble to read this book. Janet Tavakoli takes the complexities of today's derivatives markets and makes them both comprehensible and digestible for everybody from the practitioner to the interested observer." --Greg Newton, Founding Publisher, MAR/Hedge"Janet Tavakoli is exceptional in having worked extensively both in mortgage securitization and structured credit at major financial institutions. In this clearly written book, she shares her in-depth knowledge of structuring, valuation, and risk management of structured products. This book is a must read for regulators and risk managers to keep up with the latest developments in structured finance." --Joseph Masri, PhD, Barclays Global Investors, Regional Director, Professional Risk Managers' International Association (PRMIA)

Author Biography

Janet M.Tavakoli is the President of Tavakoli Structured Finance, a Chicago-based consulting firm to financial institutions, institutional investors, and hedge funds. She gave advance warning of major collapses regarding Long-Term Capital Managment, First Alliance Mortgage, the thrift industry, and the current credit bubble. BusinessWeek's profile called Tavakoli "The Cassandra of Credit Derivatives." She has over twenty years of experience trading, structuring, and marketing derivatives and structured products. Tavakoli is a former adjunct associate professor in the FinanceDepartment of the University of Chicago's Graduate School of Business, where she taught derivatives. She is also the author of the first edition of Collateralized Debt Obligations and Structured Finance and Credit Derivatives and Synthetic Structures, now in its second edition. Tavakoli is frequently published and quoted in numerous financial publications including the Wall StreetJournal, the Financial Times, BusinessWeek, Journal of Structured Finance, Derivatives Week, and many others. She also appears frequently on CNN, CNBC, CBS Evening News, Bloomberg TV, and First Business Morning News.

Table of Contents

Prefacep. xiii
Acronym Keyp. xix
Securitization Terminologyp. 1
Simplified Cash CDOp. 4
The CDO Arbitragep. 5
Structured Finance and Special Purpose Entitiesp. 7
SPCs and Historical Abusep. 10
SPEs and SPVsp. 16
Documentationp. 18
Setup Costsp. 19
Example of a Multiple Issuance Entityp. 19
Cayman-Domiciled SPEsp. 22
Repackagings to Satisfy Investor Demandp. 24
Credit-Linked Notes and Funding Costsp. 25
Structured Floatersp. 27
Principal-Protected Notesp. 27
Loan Repackagingsp. 28
Liquidityp. 29
Mismatched Maturitiesp. 29
Unwind Triggers Linked to Derivatives Transactionsp. 30
DAX-Linked Note with Triggersp. 32
Ratingsp. 34
Master Trustsp. 34
Owner Trustsp. 35
Grantor Trustsp. 36
Real Estate Mortgage Investment Conduitsp. 36
Multiseller and Single-Seller Conduitsp. 37
Domestically Domiciled Corporationsp. 39
Bankruptcy-Remote?p. 40
Enron, JPMorgan Chase, and Suretiesp. 43
Credit Derivatives and Total Rate of Return Swapsp. 45
Risk to Portfolio Valuep. 45
Credit Derivatives and Credit Default Swapsp. 47
Negotiated Languagep. 49
Basis Risk: Persistent CDS Language Issuesp. 49
Physical Settlement and Cash Settlement Negotiationsp. 50
Digital, Binary, Zero-One, All-or-Nothing, or Fixed Recovery Cash Settlementp. 52
Initial Value x (Par - Market Value)p. 53
Normalized Price Method-Alternate Termination Paymentp. 54
Hedge Costs in Cash and Synthetic CDOsp. 55
Deliverables: CDOs and the Cheapest-to-Deliver Optionp. 55
Convertible Bonds and Asset Swapsp. 56
Negative Basis Tradesp. 62
Default and Recovery Ratep. 62
The Default Protection Seller: Counterparty Credit and Correlationp. 65
Default Language for Sovereign Debtp. 65
Default Language for Nonsovereign Debt: Controversy and CDOsp. 66
CDS Pricing Issuesp. 69
Synthetic CDOsp. 70
Total Rate of Return Swaps (Total Return Swaps)p. 72
Pricing TRORS on Levered CDO Tranchesp. 74
TRORS versus Reposp. 75
Equity TRORS: Corporate Loans Disguised as Capital Injectionsp. 76
Information Asymmetry and Moral Hazardp. 78
CDS versus TRORSp. 78
Pay-as-You-Gop. 79
Indexesp. 81
CDOs and the Global Capital Marketsp. 83
Evolution of the CDO Marketp. 84
Risk and Valuation Issuesp. 91
The Portfolio Diversification Mythp. 91
Modern Portfolio Theory: Bane of CDOsp. 92
Abnormal Is Normalp. 96
Mark-to-Market Hazardp. 98
Cash Flow Hazardp. 99
Global Derivatives Riskp. 100
Loans and Leveraged Loansp. 101
The Leverage Paradoxp. 103
New Structured Finance Dealsp. 104
Fraudp. 104
Hedge Funds: A New Investor Classp. 107
Tavakoli's Law, Hedge Funds, and the Great Unwindp. 110
Brain Damage Theoryp. 112
Dead Man's Curve and Leveraged Fundsp. 113
Margin of Safety versus One-Sided Illiquid Leveraged Betsp. 114
Early CDO Technologyp. 117
True Sale Hybrid and Synthetic Structuresp. 117
Credit Enhancementp. 119
Monoline and Multiline Insurancep. 119
CDO Classificationp. 121
Market Value CDOsp. 124
Cash Flow CDOsp. 124
The Origins of U.S. Securitizationp. 126
Collateralized Mortgage Obligationsp. 135
Early Warning Commercial Financial Servicesp. 143
Rating Agencies' Failed Modelsp. 143
Anatomy of a Flawed Processp. 144
Terminologyp. 145
Early Red Flagsp. 147
CFS Gets Creativep. 149
Selling Out the Futurep. 149
Ignoring an Audit Reportp. 150
Lessons to Be Learnedp. 151
Fallout from CFS's Bankruptcyp. 153
Subprime and Alt-A Mortgages: Collateral Damagep. 155
Truthiness in Lending and Borrowingp. 158
The Predators Fallp. 160
Classic Ponzi Schemep. 162
Portfolio Riskp. 164
The Risk Managers' Dilemmap. 164
How to Create a Securitization Disasterp. 165
Models versus Common Sensep. 167
Lack of Appropriate Due Diligence and/or Disclosurep. 172
Investors and Ratingsp. 173
Hedge Funds and ABX Indexes: Alpha Betsp. 174
A Good Year (for Some)p. 177
BSAM's Hedge Funds Undone by Leveragep. 181
Bear Stearns' Hedge Fund Lenders Bailoutp. 184
Disclosure: Investor Fallout from the Mortgage Debaclep. 186
"The First Thing We Do, Let's Kill All the Lawyers"p. 188
Market Fallout from the Mortgage Debaclep. 190
Redlining and Red Inkp. 191
Cash versus Synthetic Arbitrage CDOsp. 193
Comparison of Managed Arbitrage CDO Features: Cash versus Synthetic Dealsp. 193
The Arranger and the Managerp. 195
Mandate Agreementp. 196
Deal Assemblyp. 197
CDS Language for the Synthetic CDOp. 197
Selecting the Portfolio and Impact on Ratingp. 198
Rating Criteria and Restrictionsp. 199
Substitution and Reinvestment Criteriap. 207
Warehousing Assetsp. 207
Pricing and Closingp. 208
Ramping Up the Portfoliop. 208
Reinvestment Periodp. 209
Noncall Periodp. 209
Pay-Down Periodp. 210
Weighted Average Life and Expected Final Maturityp. 210
Early Terminationp. 210
Legal Final Maturityp. 211
Tranching and the Synthetic Arbitrage Advantagep. 211
Waterfalls for Cash versus Synthetic Arbitrage CDOsp. 212
Payment-in-Kind Tranchesp. 218
Psychic Ratings: Rating Agency Treatment of PIK Tranchesp. 218
The Super Senior Advantagep. 219
CDS versus Cash Asset Spreadsp. 220
Hedging the CDO Portfolio Cash Flowsp. 226
Settlement in Event of Default or Credit Eventp. 233
Documentationp. 236
Cash versus Synthetic Arbitrage CDO Equity Cash Flowsp. 236
Sample Cash Flowsp. 237
Summary of Cash Arbitrage CDOs versus Synthetic Arbitrage CDOsp. 246
CDO Equity Structuresp. 247
Accruing Errorsp. 250
Probability of Receiptp. 253
The Best and Worst Equity Investmentsp. 254
The Best Equity Earns All Residualsp. 256
Equity Investor Injects Cash as Overcollateralizationp. 257
Rated Equity Earns Stated Coupon Appropriate to Ratingp. 259
Rated Equity: Static Dealp. 260
Equity Investor Earns a Stated Coupon on the Remaining Equity Investmentp. 262
Moral Hazard and Conflict of Interestp. 268
Leveraging the Best: Unfunded Equity Investments-Ultimate Leveragep. 270
Actively Traded and Limited Substitution Synthetic Arbitrage CDOsp. 273
Interest Subparticipations: When Equity Isn't First Lossp. 273
Participation Notesp. 276
Capped Participation Notesp. 278
Combination Notesp. 278
Investor Motivationp. 279
Principal-Protected Structuresp. 280
First- (and nth-) to-Default Basket Swapsp. 282
First-to-Default Notesp. 290
The Smartest Equity Investment: Protection Moneyp. 290
CDO Managersp. 291
Best Practicesp. 292
The Valued Fewp. 293
Balance-Sheet CLOs and CDOsp. 295
True Sale (Fully Funded): Delinked Structurep. 295
Linked Nonsynthetic Structuresp. 299
Linked Black-Box CLN CDOsp. 301
Synthetic Structure with SPEp. 304
Partially Synthetic Linked CDOsp. 307
Fully Synthetic CDOsp. 308
Small to Medium-Size Enterprises-Europep. 310
SMEs: United States versus Europep. 315
Secured Loan Trustsp. 318
Bank Regulatory Capital and Basel IIp. 321
Super Senior Sophistryp. 331
Cash Flow Magic Trickp. 333
Rating Agencies-Moody's Tranchingp. 334
The AAA Disappearing Actp. 337
Rating Agencies and Ratings Shoppingp. 338
Triple-A Basket with 2 Percent First-Loss Tranchep. 340
Super Senior Attachment Pointp. 341
Super Senior Pricingp. 342
Super Seniors or Senile Seniors?p. 343
Where Are the Regulators?p. 345
Junior Super Seniorsp. 346
Super Senior Investorsp. 347
Negative Basis Tradesp. 348
Leveraged Super Seniors and Constant Proportion Portfolio Insurancep. 349
Final Thoughts on Super Seniorsp. 350
Synthetics and Mark-to-Market Issuesp. 353
Synthetic Cash Windfallp. 353
Synthetic Equityp. 354
Portfolio Swapsp. 356
Bespoke Tranches: Single-Tranche CDOsp. 357
Short Mezzanine and Long Equityp. 359
Banks' Invisible Hedge Fundsp. 365
Extraordinary Popular Delusions and the Madness of Correlationp. 365
Delta Hedges, Correlation Models, and Junk Sciencep. 367
Synthetic Notional and Actual Riskp. 369
Explosive Growth, Uncertain Futurep. 370
Found Money and Moral Hazardp. 371
Comments on Selected Structured Finance Productsp. 373
Multisector CDOs: CDOs[superscript N]p. 373
Future Flows: Payment Rights Securitizationsp. 374
Emerging Market Caveatsp. 379
Constant Proportion Debt Obligations and Rating Agenciesp. 382
Constant Proportion Portfolio Insurancep. 384
Multiline Insurance Products: Disappointment and Promisep. 384
Hollywood Fundingp. 386
Transformersp. 388
SEC Gaslight on Life Settlementsp. 390
Special Purpose Acquisition Companiesp. 394
Credit Fundsp. 397
Credit Hedge Fundsp. 397
Hedge Funds and Structured Creditp. 398
IO and PO Tranches: Junior Tranches and Equity OIDsp. 399
Limited Purpose Finance Corporationsp. 399
Structured Investment Vehiclesp. 401
Credit Derivative Product Companiesp. 402
Hedge Funds and Collateralized Fund Obligationsp. 403
The Credit Crunch and CDOsp. 405
Rating Agencies, Regulators, and Junk Sciencep. 405
Savvy Investors Ignore Ratingsp. 407
Misfortune's Formula: Structured Credit Ratingsp. 408
ABCP Crisis and MLECp. 412
Constellation CDOs: Falling Starsp. 413
New Flawed Models Replace Old Flawed Modelsp. 415
Rating Agencies in Crisisp. 415
Monoline Meltdown: Financial Guarantors in Crisisp. 417
Rating Agencies in Denialp. 418
Overwhelming Lossesp. 419
Poor Actual Recoveriesp. 420
Undercapitalized Financial Guarantorsp. 422
Dicey Deals Done Dirt Cheapp. 422
Competitive Pressurep. 425
Uncertain Futurep. 425
Countrywide's Bailout and Moral Hazardp. 426
Future Developments in Structured Financep. 429
Regulatory Failure: Investors Are on Their Ownp. 430
Interesting Web Sitesp. 435
Bibliographyp. 437
Indexp. 439
Table of Contents provided by Ingram. All Rights Reserved.

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