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:
“The Mind that lies fallow but a single Day, sprouts up in Follies that are only to be killed by a constant and assiduous Culture.”
—Joseph Addison (1672–1719)
“Is this not true—That in proportion to the value of their estates the extremely wealthy pay far less taxes than those of moderate means? Compare the amount paid by millionaires with the amount paid by ordinary citizens. I believe that in proportion to their estates they pay less than half as much as ordinary citizens, whereas they ought to pay more.”
—Rutherford Birchard Hayes (1822–1893)
“It is a well-settled principle of the international code that where one nation owes another a liquidated debt which it refuses or neglects to pay the aggrieved party may seize on the property belonging to the other, its citizens or subjects, sufficient to pay the debt without giving just cause of war.”
—Andrew Jackson (1767–1845)
“No obligation to do the impossible is binding.”
—Marcus Tullius Cicero (106–43 B.C.)