World Famous Comics: Collateralized Debt Obligations and Structured Finance : New Developments in Cash and Synthetic Securitization
Collateralized Debt Obligations and Structured Finance : New Developments in Cash and Synthetic Securitization
By: Janet M. Tavakoli Publisher: Wiley Average Rating: Binding: Hardcover Label: Wiley Number of Items: 1 Number of Pages: 352 Publication Date: August 28, 2003
Product Description: The most cutting-edge read on CDO and credit market structures Collateralized Debt Obligations and Structured Finance provides a state-of-the-art look at the exploding CDO and structured credit products market. Financial expert Janet Tavakoli examines securitization topics never before seen in print, including the huge increase in the CDO arbitrage created by synthetics; the tranches most at risk from this new technology; dumping securitizations on bank balance sheets; the abuse of offshore vehicles by companies such as Enron; and securitizations made possible by new securitization techniques and the introduction of the Euro. This valuable guide comprehensively covers one of the fastest growing markets on Wall Street, predicting where new bank regulations and other developments may lead to product growth or product extinction. While providing an overview of the market and its dynamic growth, Collateralized Debt Obligations and Structured Finance explores the types of products offered, hedging techniques, and valuation and risk/return issues associated with investment in CDOs and synthetic CDOs. Janet M. Tavakoli, MBA (Chicago, IL), has over eighteen years of experience trading, structuring, and marketing derivatives and structured products with major financial institutions in New York and London. She is also the author of Credit Derivatives and Synthetic Structures, now in its Second Edition (0-471-41266-X).
Intriguing Expose of CDOs The volume of collateralized debt obligations has ramped up so rapidly in recent years that the level of expertise needed to transact business in these products competently is very uneven. Experts often disagree on the basic terminology. Both of these related problems are linked to a third problem - opportunities for fraud. Tavakoli addresses this market's growing pains in this book.
Tavakoli tackles terminology at the very beginning and objects to the lazy practice of using the term "arbitrage" to refer to any hedged position that has made money such as referring to a long bond position being "arbitraged" by a short sale. A true arbitrage is a risk-free profit opportunity. Arbitrage language in the CDO context helps parties hide from themselves the fluctuating nature of the profit (and loss) conditions that they actually face. This is also true of "delta" hedging.
This is a recurring theme in this book: Participants first need to get the words right in order to get the concepts right, and they have to do both in order to get the numbers right. Another example is the "dual currency swap." A borrower receives one currency, pays coupons in another currency and has a final exchange of principal in a third currency. "Borrowers often perform this swap when they want to lower their all-in borrowing costs by taking on more currency risk," Ms. Tavakoli explains.
But the term "dual currency swap" also is used quite broadly for transactions in which fixed-rate bonds denominated in one currency simply are swapped for floating-rate bonds denominated in another. Ms. Tavakoli suggests that her readers should not assume that market professionals know the correct terminology. "Ask for the cash flow structure in writing, so you can determine the cash flows to see if they are consistent with the terminology as you understand it."
Tavakoli introduces a valuable distinction between timing and frequency, both terms important to the clear understanding of the cash flow that a contemplated transaction will produce. "It is not sufficient to state that I will get all of my cash back within the year," Ms. Tavakoli writes, explaining the distinction. "This is merely the timing of my ultimate receipt of cash flows. I want to know the frequency. Will I receive the cash flow in one lump sum toward the year-end, in equal monthly payments, or in a varied stream of payments over the course of the year? I'm not indifferent. This is why I emphasize timing and frequency."
This is an intriguing book. The market in collateralized debt obligations is complicated, subject to a miasma of human frailties. Hedge funds have entered this market in droves, particularly the synthetic market, and banks curry their favor as customers and competitors. As Tavakoli points out "find ways to become comfortable with alternative investors ... because this customer base is a key consumer of leveraged risk. They do not have the same regulatory capital constraints as banks."
Hedgers Manual This book gives the best explanation I've ever read of the cash and synthetic collateralized debt obligations markets. Especially clear is the extra cash injection due to the large synthetic super senior tranche, which does not exist in the cash market. Tavakoli's book is the only one that discusses the language arbitrage and rating ambiguity. As a quant and delta hedger, I would have liked more on correlation trading and delta hedging, since this book pre-dates this, but the overview of how the cash flows work is excellent.
Creates More Questions than it Answers Poorly written - poorly edited This book needs a complete rewrite Its more a collection of disjointed notes and facts than a book If you don't understand CDOs before you read it - you won't after you read it
Straight Steering in Structured Finance Even the experts have trouble understanding the various complex structures in the collateralized debt obligation market. In this book, Tavakoli does for CDOs what she did for Credit Derivatives. She makes sense of the confusing terminology, shines a bright light on the key issues, and discusses how to avoid the potential for fraud.
She clarifies what the rating agencies miss. For instance, in a dispute between a German bank and a British bank that was recently settled in London, the British bank was alleged to have misled the buyer and then taken advantage of the buyer by substituting fallen angels into the CDO portfolio. Rating agencies don't capture this type of risk. Tavakoli explains how ratings won't save investors, but paying careful attention to the portfolio trading constraints in the deal documentation will. She recommends rewriting any "standard" document that doesn't adequately protect an investor's interest by adding trading rules and restrictions (if it is allowed at all), reserve accounts, and other structural protections.
She also debunks the term CDO "arbitrage." This "arbitrage" is not risk-free for the investment banks who arrange these deals, but using this term gives comfort to bank managers who may be unaware of the hidden volatility in their trading portfolios. Very inconvenient when one can't transfer the risk to an unwary investor's portfolio. Tavakoli points out that single tranche CDOs in which one is long the super senior and equity and short the mezzanine tranche can turn the trading book into a delta hedging parking lot. She also points out that CDOs squared put you at risk for having some of the least advantageous structures stuffed as collateral into a portfolio. If it requires diligence and rewriting the documents to get a fair deal in a CDO, why would you accept tranches from deals that you didn't have a chance to rework? Put in this context, buyers of those types of deals should demand a huge premium. These deals are beyond the scope of meaningful ratings, and nearly impossible to properly model in the secondary market.
The language is precise, and as she points out it can even be more important than understanding the numbers, since overwhelming risk can come from inadequate documentation. If you are an investor, don't venture into the world of collateralized debt obligations without reading this book. If you are trading these tranches, this book will give you details about these products you won't find anywhere else.
Where was the editor? As a novice to securitizations, I can't speak about the merits of this book in comparison to its peers. However, I will say that it is neither a reference book nor a novel. The overall structure and organization of the book was horrendous with stories leading nowhere and technical examples blurted out onto the page without thought to a fundamental theme or why they were offered. An example is not a good teaching lesson if it doesn't relate to a fundamental point.
I don't blame the author because she is obviously skilled and well informed. I do blame the editor for not reviewing the book more carefully. Wiley shame on you!
Anything Goes Trivia
Megaton Man
Trevor
