Systematic study on the collapse of CDO market in the subprime crisis

• Main Authors: Aw, Lay Hoon, Chia, Henry Ching Hwee, Koh, Kendra Swee Hiang
• Other Authors: Cao Yong
• Format: Final Year Project
• Language: English
• Published: 2009
• Subjects: DRNTU::Business::Finance::Financial institutions
• Online Access: http://hdl.handle.net/10356/15063
• Institution: Nanyang Technological University

In mid 2007, the financial market was severely hit by the collapse of the housing market. This financial turmoil resulted in the collapse of big investment banks such as Bear Stearns and Lehman Brothers, acquisition of Merrill Lynch by Bank of America and transformation of Goldman Sachs and Morgan Stanley into bank holding companies. Many questioned: How could a housing bubble burst send Wall Street to complete chaos, thus, compel government intervention to salvage the situation? What was the key reason that led to their downfall and, subsequently the collapse of the financial market? The Collateralised Debt Obligation (CDO)market has grown rapidly over the recent years, mainly contributed by growing share of structured products (such as tranches of mortgagebacked securities or of other CDOs); signifying the rising demand for more risky investment. In view of the securitisation technology, which amplifies the impact on defaults, these complex products have been closely associated with our recent financial turbulence. With the engagement of financial intermediaries, subprime mortgage related securities had constituted a major portion in the asset base of most investment banks, which facilitated the securitisation process through Structured Investment Vehicles (SIVs). This had significantly contributed to meltdown of the financial market after the collapse of the subprime mortgage market. Therefore, this research report seeks to investigate the employment of the securitisation technology in the credit market, as well as, the mechanics and fundamental elements of CDO; revealing its sensitivity to market changes and paradox of diversified and standardised of credit exposure in a CDO; and the magnified impact of default risk on the underlying with the application of securitisation technology. This report also seeks to identify the involvement of key financial entities in the CDO securitisation process and the repercussions of their actions.