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:
“A tart temper never mellows with age, and a sharp tongue is the only edged tool that grows keener with constant use.”
—Washington Irving (1783–1859)
“I was glad to have got out of the towns, where I am wont to feel unspeakably mean and disgraced,—to have left behind me for a season the bar-rooms of Massachusetts, where the full-grown are not weaned from savage and filthy habits,—still sucking a cigar. My spirits rose in proportion to the outward dreariness. The towns needed to be ventilated. The gods would be pleased to see some pure flames from their altars. They are not to be appeased with cigar-smoke.”
—Henry David Thoreau (1817–1862)
“This is the debt I pay
Just for one riotous day,”
—Paul Laurence Dunbar (1872–1906)
“The only obligation to which in advance we may hold a novel, without incurring the accusation of being arbitrary, is that it be interesting.”
—Henry James (1843–1916)