Leveraged financing is back in the reckoning this time with a new feature. This new instrument has drawn a lot of attention of both institutional and individual investors and is all set to transform the definition of risk-return profile.
For millions, trade-off between risk and return is the best attraction that induces them to fancy their chances. Whether it is an individual or an institutional investor, mastering this game is the ultimate goal. Moreover, to master this, they find new investment avenues and new instruments. Right from the stock market trading to trading in forex options, futures and swaps, financial engineering has been behind these investors to come out with the new instruments. Soon after the debacle of long-term capital management, everyone associated with Wall Street went into a shock. However, financial engineering found a new way of leveraged financing, which contains the best risk-return trade-off investors would like to fancy. The newfound choice of millions of investors both institutional and individual has grown very fast in the last two years. The choice is Collateralized Debt Obligations (CDOs). Packed with debt and equity loans, it offers the best risk return profile.
The underlying assets of a CDO make it so, more than anything else. The broad definition is that it is securitization of corporate obligations. The underlying that is securitized can be classified as corporate loans, commercial loans, corporate bonds, asset backed securities and emerging market debt. Though different assets are securitized to make a CDO, securitizing corporate loans and bonds mostly constitute it. The growth of CDO market has been phenomenal as in 1995 only $1 bn in rated CDOs were offered. This grew to $ 82 bn in the last year. According to Moody's Investor Services, this market is expected to grow by another 20-30 percent in the present year.
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