A Constant Proportion Debt Obligation (or CPDO) is a type of credit derivative sold to investors looking for long term exposure to credit risk on a highly rated note. They employ dynamic leveraging in a similar (but opposite) way to Credit CPPI trades.
CPDOs formed, first by creating a SPV which will issue some debt. The SPV will be backed by an investment in an index of debt securities (commonly credit default swap indices such as CDX and iTraxx. In theory this could be deal-specific, such as a bespoke index of sovereign debt) similar to a CDO. The investment index is periodically rolled, whereby the SPV must buy protection on the old index, and sell protection on the new index. In doing so, it incurs rollover risk, in that the leaving index may by priced much wider than the new index. The structure then allows for continual adjustment of leverage such that the asset and liability spreads stay matched. In general this involves increasing leverage as when losses are taken, similar to a doubling strategy, in which one doubles one's bet at each coin toss until a win occurs.
Read more about Constant Proportion Debt Obligation: Initial Reaction, Credit Crunch
Famous quotes containing the words constant, proportion, debt and/or obligation:
“I am constant as the northern star,
Of whose true-fixed and resting quality
There is no fellow in the firmament.”
—William Shakespeare (1564–1616)
“It was obvious that the size of your chest was in direct proportion to the size of your salary.”
—Cynthia Hess, U.S. exotic dancer. As quoted in Newsweek magazine, p. 19 (April 25, 1994)
“They who have been bred in the school of politics fail now and always to face the facts. Their measures are half measures and makeshifts merely. They put off the day of settlement, and meanwhile the debt accumulates.”
—Henry David Thoreau (1817–1862)
“The debt was the most sacred obligation incurred during the war. It was by no means the largest in amount. We do not haggle with those who lent us money. We should not with those who gave health and blood and life. If doors are opened to fraud, contrive to close them. But don’t deny the obligation, or scold at its performance.”
—Rutherford Birchard Hayes (1822–1893)