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CPDO: Constant Proportion Debt Obligation… The last mistake by rating agencies

CPDO stands for constant proportion debt obligation… But I am not sure you are any clearer now in any way, shape or form. Let me try to make this one simple.

A CPDO was a new form of market value credit structured product. Developed in 2007 by ABN AMRO and subsequently improved by UBS, LEHMAN and others. It looked and felt as a bond with a Euribor+1% coupon… nice, though.

The way it worked was very basic. Lets assume a 5 year transaction with European investment grade credit exposure, the so called Itraxx (125 names in the index that resembles Eurostoxx in the credit world) on a EUR 10m. notional.

Investor was long credit exposure leveraged 10 times (for example). If credit gets cheaper (credit spreads widen) then leverage increases to 11, 12, … up to 15 times. Basically when credit is cheap you buy it and the other way around when credit becomes expensive (therefore credit spreads tightens).

This means that on day one you are long 10 times the notional at risk, in this case EUR 100m (10x10m).

The beauty of CPDOs was that Moody