LOS g: Distinguish among the primary motivations for creating a collateralized debt obligation (arbitrage and balance sheet transactions).

Q1. Which of the following statements is least likely to be considered an advantage generally associated with collateralized debt obligations?

A)   Through the issuance of a CDO, an issuer can maintain legal ownership of the underlying assets but can transfer the economic risks to an investor.

B)   The senior tranche of a CDO provides an attractive fixed-rate vehicle for fixed-rate investors.

C)   The spread between an asset’s return and the associated cost to finance the asset can be “locked-in” through the issuance of a CDO.

Q2. Which of the following statements regarding collateralized debt obligations (CDOs) is least accurate?

A)   In the market today, the majority of cash CDO issued are balance sheet-driven.

B)   A CDO’s collateral pool will typically contain some combination of fixed-rate and floating-rate debt instruments.

C)   The main purpose behind an arbitrage-driven cash CDO is to capture the spread between the return on the collateral and their funding costs.

Q3. A $350 million collateralized debt obligation (CDO) was recently issued by a large Wall Street firm. The portfolio manager will actively manage the underlying assets, and will sell assets periodically in order to generate the cash flow necessary to pay the CDO’s tranches as outlined in the prospectus. This type of CDO is most appropriately described as a:

A)   arbitrage-driven cash CDO.

B)   market value CDO.

C)   cash flow CDO.

LOS g: Distinguish among the primary motivations for creating a collateralized debt obligation (arbitrage and balance sheet transactions). fficeffice" />

Q1. Which of the following statements is least likely to be considered an advantage generally associated with collateralized debt obligations?

A)   Through the issuance of a CDO, an issuer can maintain legal ownership of the underlying assets but can transfer the economic risks to an investor.

B)   The senior tranche of a CDO provides an attractive fixed-rate vehicle for fixed-rate investors.

C)   The spread between an asset’s return and the associated cost to finance the asset can be “locked-in” through the issuance of a CDO.

Correct answer is B)

The senior tranche of a CDO will most likely be structured with a floating-rate coupon, and the mezzanine tranches will have a fixed-rate payment.

Q2. Which of the following statements regarding collateralized debt obligations (CDOs) is least accurate?

A)   In the market today, the majority of cash CDO issued are balance sheet-driven.

B)   A CDO’s collateral pool will typically contain some combination of fixed-rate and floating-rate debt instruments.

C)   The main purpose behind an arbitrage-driven cash CDO is to capture the spread between the return on the collateral and their funding costs.

Correct answer is B)

The majority of cash CDOs issued are arbitrage-driven, in which the issuer is trying to capture the spread between the underlying assets and the costs to finance them.

Q3. A $350 million collateralized debt obligation (CDO) was recently issued by a large Wall Street firm. The portfolio manager will actively manage the underlying assets, and will sell assets periodically in order to generate the cash flow necessary to pay the CDO’s tranches as outlined in the prospectus. This type of CDO is most appropriately described as a:

A)   arbitrage-driven cash CDO.

B)   market value CDO.

C)   cash flow CDO.

Correct answer is B)

The manager of a market value CDO will actively manage the portfolio to generate sufficient cash flows. This is in contrast to a cash flow CDO, where the portfolio is structured at inception in such a way that its principal and interest payments can pay the tranches and trading profits will not be needed to support the cash flows of the CDO.

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