[CDO Economics] The concept of the collateral, portfolio losses, returns to equity, and the collateral earnings rate
I was wondering if someone could explain to a newbie how the economics of a CDO works.
To be more specific, I have the following few questions:
1. What is the collateral? Is it the bond(s)/debt in the company, the business operations of the company that issued the debt, or something else?
2. What is the collateral yield and how is it calculated? Is the collateral yield the same as the collateral earnings rate? If not, what is the collateral earnings rate and how is it calculated?
3. How is an adequate or above-average risk-adjusted return on the equity tranche achieved?
4. What is a portfolio loss? Is it if the debt defaults, or something else?
5. How are the portfolio losses calculated in order to compare it to the earnings spread to get to the returns to the equity tranche?
Feel free to explain other issues I've missed.
Thanks!
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