Are EM Bonds Fit For CDOs?

Jun 1, 2002

With better than expected default rates and improving ratings, emerging market bonds - including those from Latin America - deserve a serious look from the collateralized debt obligation marketplace.

One of the fastest-growing segments in the fixed income market has been collateralized debt obligations (CDOs), the innovative $250 billion universe of repackaged instruments. The concept is simple: take a pool of debt with a blended credit rating and cut the pool into different asset classes with varying risk/return profiles based on seniority in the capital structure. CDOs grew out of the collateralized mortgage obligation (CMO) marketplace when it became clear that there might be a funding cost reduction when securities were pooled and resold in different tranches. CDOs now include high yield and investment-grade bonds, leveraged bank loans, emerging market bonds and asset-backed securities. Under a typical CDO, bonds with a common maturity are placed in a trust and various capital tranches of the trust are rated. Such pools require significant diversity requirements in terms of industry and domicile, and have limits on issuer and issuer-type concentrations. The...

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