Synthetic CDO

AAA

DEFINITION of 'Synthetic CDO'

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.

INVESTOPEDIA EXPLAINS 'Synthetic CDO'

Synthetic CDOs are a modern advance in structured finance that can offer extremely high yields to investors. However, investors can be on the hook for much more than their initial investments if several credit events occur in the reference portfolio.

Synthetic CDOs were first created in the late 1990s as a way for large holders of commercial loans to protect their balance sheets without actually selling the loans and potentially harming client relationships. They have become increasingly popular because they tend to have shorter life spans than cash flow CDOs and there is no extended ramp-up period for earnings investment. Synthetic CDOs are also highly customizable between the underwriter and investors.

VIDEO

RELATED TERMS
  1. Collateralized Loan Obligation ...

    A security backed by a pool of debt, often low-rated corporate ...
  2. Forward Contract

    A customized contract between two parties to buy or sell an asset ...
  3. Collateralized Debt Obligation ...

    An investment-grade security backed by a pool of bonds, loans ...
  4. Bespoke CDO

    A type of collateralized debt obligation (CDO) that a dealer ...
  5. Collateralized Bond Obligation ...

    An investment-grade bond backed by a pool of junk bonds. Junk ...
  6. Credit Default Swap - CDS

    A swap designed to transfer the credit exposure of fixed income ...
Related Articles
  1. The CMO issuer redirects the loan payments from the mortgages and distributes both the interest and principal to the investors in the pool.
    Investing Basics

    CMO vs CDO: Same Outside, Different Inside

    The concept of collateralizing and structured financing predates the market for collateralized mortgage obligations and collateralized debt obligations.
  2. Options & Futures

    Massive Hedge Fund Failures

    Flying high one day but not the next - see the stories behind some spectacular meltdowns.
  3. Mutual Funds & ETFs

    Who Is To Blame For The Subprime Crisis?

    From lenders to buyers to hedge funds, it appears everyone has blood on their hands.
  4. Personal Finance

    The Fuel That Fed The Subprime Meltdown

    Take a look at the factors that caused this market to flare up and burn out.
  5. Insurance

    Futures Fundamentals

    For those who are new to futures but want a solid understanding of them, this tutorial explains what futures contracts are, how they work and why investors use them.
  6. Investing Basics

    The Most Popular Bitcoin Mining Software

    Success at mining bitcoins depends on the combination of time, knowledge, computer hardware and the complementary software.
  7. Options & Futures

    What are the differences between divergence and convergence?

    Find out what technical analysts mean when they talk about a market experiencing divergence or convergence and how they affect trading strategies.
  8. When trading in financial markets, higher returns are generally associated with higher risk. Hedge your risk with interest rate swaps.
    Investing Basics

    How Are Interest Rate Swaps Valued?

    When trading in financial markets, higher returns are generally associated with higher risk. Hedge your risk with interest rate swaps.
  9. Mutual Funds & ETFs

    What is the difference between a hedge fund and a private equity fund?

    Learn the primary differences between hedge funds and private equity funds, both of which are utilized by high net worth investors.
  10. With stocks surging, financial advisers and their wealthy clients are asking why they should continue to bother with poorly performing alternatives.
    Professionals

    Are Advisors Off Alternatives?

    With stocks surging, financial advisers and their wealthy clients are asking why they should continue to bother with poorly performing alternatives.

You May Also Like

Hot Definitions
  1. Deferred Revenue

    Advance payments or unearned revenue, recorded on the recipient's balance sheet as a liability, until the services have been ...
  2. Multinational Corporation - MNC

    A corporation that has its facilities and other assets in at least one country other than its home country. Such companies ...
  3. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
  4. Simple Interest

    A quick method of calculating the interest charge on a loan. Simple interest is determined by multiplying the interest rate ...
  5. Special Administrative Region - SAR

    Unique geographical areas with a high degree of autonomy set up by the People's Republic of China. The Special Administrative ...
  6. Annual Percentage Rate - APR

    The annual rate that is charged for borrowing (or made by investing), expressed as a single percentage number that represents ...
Trading Center