What are Collateralized Debt Obligations (CDOs)? (2008 Financial Crisis Explained)
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Let's take a look at
Let's take a look at Collateralized Debt Obligations, or CDOs, and also take a look at something called a Credit Default Swap.
Watch the full video about mortgage-backed securities here: What are Mortgage-Backed Securities? ...
CDOs are types of mortgage-backed securities. In the example we posed before, MBS are simple shares of a company where every share gets the same amount back. CDOs are still shares of that company, but they have different levels of how much you get back, called tranches. Let's say the Investment bank wanted to split Big Mortgage Corp into 3 tranches: Equity, Mezzanine, and Senior. These are the actual names used in the industry. Each tranche, or level, holds a handpicked number of shares from Big Mortgage Corp.
Equity is the lowest level, highest risk but highest return. They hold the shares of the riskiest mortgages. If borrowers default, holders of equity level CDOs are the first to feel the pain. However, if borrowers do end up paying up, the Equity tranche gets back the most money. For example, rather than 5%, let's say they get back 7.5% on their investment. If you want to take the risk, it could pay off!
The next level is Mezzanine. These are the middle of the road CDOs. Moderate risk and moderate risk of default. Let's say they get back 5% of their investment.
The safest level is the Senior Tranche. They hold very little risk but get lower return. If a ton of borrowers default, Big Mortgage Corp is going to underpay Equity and Mezzanine tranches to make sure the Senior tranche get's their money. However, the Senior Tranche let's say only earns a 3.13% interest rate.
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Watch the full video about mortgage-backed securities here: What are Mortgage-Backed Securities? ...
CDOs are types of mortgage-backed securities. In the example we posed before, MBS are simple shares of a company where every share gets the same amount back. CDOs are still shares of that company, but they have different levels of how much you get back, called tranches. Let's say the Investment bank wanted to split Big Mortgage Corp into 3 tranches: Equity, Mezzanine, and Senior. These are the actual names used in the industry. Each tranche, or level, holds a handpicked number of shares from Big Mortgage Corp.
Equity is the lowest level, highest risk but highest return. They hold the shares of the riskiest mortgages. If borrowers default, holders of equity level CDOs are the first to feel the pain. However, if borrowers do end up paying up, the Equity tranche gets back the most money. For example, rather than 5%, let's say they get back 7.5% on their investment. If you want to take the risk, it could pay off!
The next level is Mezzanine. These are the middle of the road CDOs. Moderate risk and moderate risk of default. Let's say they get back 5% of their investment.
The safest level is the Senior Tranche. They hold very little risk but get lower return. If a ton of borrowers default, Big Mortgage Corp is going to underpay Equity and Mezzanine tranches to make sure the Senior tranche get's their money. However, the Senior Tranche let's say only earns a 3.13% interest rate.
Get a free stock with WeBull: https://bit.ly/2tBxZYv
Get a free stock with Robinhood: http://bit.ly/2p4kQC2
All images and videos courtesy of the creative commons or used in accordance with fair use laws. For questions or concerns, please use the contact section on our channel
Music:
Divider by Chris Zabriskie is licensed under a Creative Commons Attribution license (https://creativecommons.org/licenses/...)
Source: http://chriszabriskie.com/divider/
Artist: http://chriszabriskie.com/
Brittle Rille - Reunited by Kevin MacLeod is licensed under a Creative Commons Attribution license (https://creativecommons.org/licenses/...)
Source: http://incompetech.com/music/royalty-...
Artist: http://incompetech.com/
CGI Snake by Chris Zabriskie is licensed under a Creative Commons Attribution license (https://creativecommons.org/licenses/...)
Source: http://chriszabriskie.com/divider/
Artist: http://chriszabriskie.com/
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