Credit Derivatives and Synthetic CDOs

This chapter provides the basic information for new investors as well as more detailed analysis for experienced investors. It contains five sections, which build on each other. The first section examines the terminology and mechanics of credit default swaps on corporate entities, asset-backed securities, and CDOs. In the second section, it discusses the most actively traded CDS indexes and tranches of these indexes. It also explores tranche trading strategies and market dynamics in the third section. In the fourth section, it discusses of credit default swaps to explain the dynamics of synthetic CDOs. The chapter concludes with a section where it discusses correlation. Correlation is the term used to describe the degree to which defaults are synchronized among collateral names and tranche trading strategies are often called correlation trades.