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CDOs

Basic Mechanics

If losses on the assets held by the SPV occur

They are applied first to the “Equity” or lowest tranche

Which reduces in size

If losses outgrow the size of the Equity tranche

They are applied to the next lowest tranche

And so on

INCOME flows to the Senior tranche first and then DOWN

LOSSES flow to the Lowest tranche first and then UP

Note : the Equity tranche is usually retained by the originator

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