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Synthetic CDOs

Basic Mechanics

Tranche system is the same as with standard CDOs

Senior through Mezzanine to Equity

But proceeds of the Notes (tranches) used to

Purchase high-quality assets (collateral)

Which fund notes issued

Purchase portfolio of CDS from originator

i.e. SELL protection to originator

CDS premium also goes to funding notes

Effect is same as with standard CDO

Less expensive and faster than using physical assets

In the case of a credit event

SPV sells collateral to pay originator

And reduces size of relevant tranche

Equity tranche reduced first and so on

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