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FRM Part I · FRM Exam Part I · Credit Risk Transfer Mechanisms

Compared with a traditional cash securitization, a synthetic CDO primarily differs in that it:

A synthetic CDO transfers the credit risk of a reference portfolio through credit default swaps rather than selling the underlying assets. The originator keeps the loans or bonds, while investors in the tranches receive premiums and bear losses on the reference portfolio.

  1. Atransfers credit risk using credit default swaps without a sale of the underlying assetsCorrect
  2. Brequires the originator to remove the reference loans from its balance sheet through a true sale
  3. Celiminates counterparty risk because no derivative contracts are used
  4. Dpays investors only from the principal repayments of physical bonds held by the SPV

Explanation

A synthetic CDO gains exposure to a reference portfolio through credit default swaps, so the assets stay with the originator and risk is transferred only. A true sale is a feature of cash deals. Synthetics involve derivatives and thus counterparty risk.

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