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:
“For me, it is as though at every moment the actual world had completely lost its actuality. As though there was nothing there; as though there were no foundations for anything or as though it escaped us. Only one thing, however, is vividly present: the constant tearing of the veil of appearances; the constant destruction of everything in construction. Nothing holds together, everything falls apart.”
—Eugène Ionesco (b. 1912)
“Man is the only animal which esteems itself rich in proportion to the number and voracity of its parasites.”
—George Bernard Shaw (1856–1950)
“Let every man, every corporation, and especially let every village, town, and city, every county and State, get out of debt and keep out of debt. It is the debtor that is ruined by hard times.”
—Rutherford Birchard Hayes (1822–1893)
“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)