Functions Served by the Collateral Manager for CDOs
Original post by Lexa W. Lee of Demand Media
A collateralized debt obligations (CDO) is an investment-grade security that pools together unrelated debt-instruments, such as bonds and loans, and then sells shares of it to investors. The collateral manager for a CDO is an independent party who acts as an administrator on behalf of the investors. His job is to optimize the performance of the CDO.
Who Buys CDOs?
CDOs have spread across the world. They typically have a sponsoring institution such as an investment bank, an arrangement that reduces the requirements for regulatory capital and funding costs while expanding lending capacity. The sponsoring institution can also sell assets and transfer risk to the CDO. CDOs, which are not traded on stock exchanges, are typically bought by banks, insurance groups, pension funds and investment managers.
How It Works
CDOs became attractive because investors saw them as a better way to earn higher returns with less risk, compared to other available investments. Most CDOs are actively managed. The expertise of the collateral manager is crucial to the performance of the CDO. The collateral manager is responsible for acquiring and managing assets to maximize gains and minimize losses for investors.
Many CDOs are divided into different classes of rated and unrated securities, such as bonds, mortgages and other loans that range from poor to high quality debt, based on risk. The collateral manager can reinvest in securities when possible and appropriate. He is also responsible for selling other securities that may default and pose a credit risk. He then reinvests the proceeds in the CDO or uses them to pay its debts.
Although a collateral manager is responsible for monitoring the credit risk of securities in a CDO, the actual risks involved are not always easy to determine, by either the collateral manager or investors. So-called credit blow-ups can occur as a result. When banks invest in CDOs with a large group of risky securities that go into default, they can lose large amounts of money. This means they will have less money to lend to consumers. collateral manager (reference
- Investopedia; CDOs And The Mortgage Market; January 2011
- Leonard N. Stern School of Business: The CDO Product
About the Author
Lexa W. Lee, a writer based in New Orleans, has freelanced for more than 20 years. Her clients have included WebMD, EverydayHealth.com, "Self", "Central Nervous System News", "Journal of Naturopathic Medicine" and TennisDiary.com. She was a postdoctoral researcher in immunology and holds a Bachelor of Science in biology from Reed College as well as a naturopathic medical degree from National College of Naturopathic Medicine.