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DEFINITION of 'Collateralized Debt Obligation Squared - CDOSquared'

A special purpose vehicle (SPV) with securitization payments in the form of tranches. A
collateralized debt obligation squared (CDO-squared) is backed by a pool of collateralized debt
obligation (CDO) tranches.

INVESTOPEDIA EXPLAINS 'Collateralized Debt Obligation

Squared - CDO-Squared'
This is identical to a CDO except for the assets securing the obligation. Unlike the CDO, which
is backed by a pool of bonds, loans and other credit instruments; CDO-squared arrangements
are backed by CDO tranches. CDO-squared allows the banks to resell the credit risk that they
have taken in CDOs.

Down The Rabbit Hole:

Deciphering CDOs
You have probably heard a lot about derivatives over the past two years.
Derivatives are largely responsible for the fall of banking giants Bear Stearns,
Lehman Brothers and Washington Mutual. Derivatives also contributed to the
collapse in the housing market and were a big part of the need for government
Warren Buffett refers to derivatives as financial weapons of mass destructions.
They are often traded in secrecy and are the subject of many backroom
transactions. Lets shine a little light on one specific type of derivatives known as
collateral debt obligations or CDOs.
Understanding CDOs
CDOs are collateralized debt obligations. If you dont know what that is, youre
not alone; no one on Wall Street seems to know what they are, either! PBS does a
good job of explaining a CDO. A CDO is an investment-grade security backed by
a pool of various other securities. CDOs can be made up of any type of debt, in
the form of bonds or loans. These obligations are then divided into slices that
contain debts with various levels of risk. These different slices of risk are referred
to as tranches. Every tranche has its own credit rating.

How It Works
CDOs are constructed as a way of selling cash flows to investors. Good and bad
debts are packaged together to get higher ratings from rating agencies thereby
making them highly indistinguishable from one another. An investor could
purchase a CDO with investment grade debt and junk grade debt all contained in
the same portfolio. This makes it nearly impossible for investors to figure out
what they are buying. Even the rating agencies have no idea how to rate these
Many CDOs receive an AAA rating despite having just a few investment-grade
securities mixed in with mostly junk debt. They may as well rate every CDO AAA
as long as it has one highly rated security in the whole deal. Thats like placing a
rose on top of a pile of garbage and calling it a flower bed.
The Problem with CDOs
The main problem with CDOs is that these structured asset-backed securities
have so many different layers that no one understands exactly whats in them.
Dont just take my word for it. Famed investor Warren Buffett once said, If you
take one of the lower tranches of the CDO and take 50 of those and create a CDO
squared, youre now up to 750,000 pages to read to understand one security. I
mean, it cant be done. When you start buying tranches of other instruments,
nobody knows what the hell theyre doing.
There is a serious problem with CDOs if our generations greatest investor
doesnt understand how these financial instruments work.
A Moneymaker for Financial Institutions
If CDOs are such a mess, why do financial institutions sell them? Because they
can make money selling them! The origination and securitization of loans is big
business for banking institutions. Investment banks that sell CDOs receive huge
commissions when the CDO is first sold and residual commissions over the life
of the obligation.
The primary focus of CDO issuers is to sell a large quantity of products because
that is what makes the money for the firm. Firms pay more attention to the
quantity of loans being issued than the quality of loans being written. Who
would have thought that investment banks would only be concerned about
making money?

OK, you can see why investment banks sell these CDOs, but why do investors
purchase them? The simple reason is greed. The more risk a CDO has, the higher
the potential payout. Investors want the income generated by the outstanding
debt but dont want to purchase the underlying security itself. CDOs were
designed to be insurance policies, but instead of reducing risk for investors, they
simply spread the risk around to everyone.
CDO Wrap-Up
CDOs are highly technical and complex financial products that were designed for
sophisticated investors. That sounds great until you realize that theres no one on
the earth sophisticated enough to understand them.


I collateralized dept obligations o CDO, sono prodotti strutt