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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.