Reasons for creating CDOs
CDOs are arranged for a number of reasons.
• Spread arbitrage. Often the sale price of notes exceeds the initial Value of underlying assets, as notes have a more favourable risk-return Profile due to diversification.
• Tranching makes it possible to turn a large part of the assets Into high-quality securities that are attractive for many investors: [Hull and White, 2010] “ for a typical ABS about 75% to 80% of The underlying mortgage principal is allocated to tranches with a AAA rating
• Regulatory capital relief. Important reason for balance-sheet CLOs; The structure enables banks to sell some of their credit risk but Maintain borrower-lender relationship.