Example on cash flow diagram, Financial Management

Assignment Help:

(a) A usual cash flow diagram will incorporate the following. If you are short the CDO and then you receive a fixed amount at the initial point to. After that you make payments made of a floating risk-free rate plus a fixed spread. Nevertheless if one or more of the underlying credits default your share of the defaulted amount will be deducted from the coupon.

(b) Ever since you are receiving a spread over a floating rate the interest rate risk is minimal. There are a few risks only between the coupon payments dates. This is able to be hedged using strips of FRA's. Or else by using swaps as the reading suggests.

Or else the CDO is an investment vehicle and the investor is exposed to changes in the credit curve. If necessary such risks are able to be hedged by taking positions on a proper set of CDSs.

(c) A refuse of the overall level of interest rates means the floating rates are going down. If the investor is hedged trough the FRA's this will have no effect on the overall returns. Alternatively if default rates increase the value of the CDO will decline.

(d) As underlying credits default this will reduce the principal amount involved in the CDO during its life cycle. Alternatively if such a CDO is hedged using a swap and the swap notional will remain fixed

This signifies that a plain vanilla swap will end up introducing a basis risk. But a customized swap where the swap notional decreases as CDO principal changes will be more expensive.


Related Discussions:- Example on cash flow diagram

Need for assessing the risks , Define risk. Examine the need for assessing ...

Define risk. Examine the need for assessing the risks in a project

Discount Pricing, Discount Pricing The T-bills are issued at a discount...

Discount Pricing The T-bills are issued at a discount to face value and hence have no coupon. Commission rates on round lots generally range from $12.50 to $25.00 per $1 mil

What are retained earnings, What are retained earnings?  Why are they impor...

What are retained earnings?  Why are they important? Retained earnings represent the total of all the earnings available to common stockholders of a business during its complet

Function of the investment decision, Q. Function of the Investment decision...

Q. Function of the Investment decision? Investment decision related of the selection of the fixed assets. the assets can be acquired fall into two board groups i) long terms

Importance of the cost of capital, Q. Importance of the Cost of Capital? ...

Q. Importance of the Cost of Capital? Importance of the Cost of Capital:- (1) Useful in Designing the Capital Structure: - The perception of cost of capital plays a very imp

Find out the macro consequences of a reduction, Angel Athletics is trying t...

Angel Athletics is trying to determine its optimal capital structure. The company's capital structure consists of debt and common stock. In order to estimate the cost of debt, the

Letter of credit (loc), Letter of Credit (LOC) A popular bank instrumen...

Letter of Credit (LOC) A popular bank instrument begins that a bank has granted the holder an amount of credit equal to the face amount of the L/C. A bank guarantees payment of

Dividend yield plus growth in dividend method, Dividend yield plus growth i...

Dividend yield plus growth in dividend method When the dividends of the firm are predictable to grow at a constant rate and the dividend payout ratio is constant, this techniq

Criticism of profit maximization approach, Criticism of Profit Maximization...

Criticism of Profit Maximization Approach: (i) Ambiguous: - One practical complexity with this approach is that the term profit is ambiguous. Different people take dissimilar me

Leverage, EVALUATE THE IMPORTANCE OF LEVERAGE IN FINANCIAL MANAGEMENT OF SM...

EVALUATE THE IMPORTANCE OF LEVERAGE IN FINANCIAL MANAGEMENT OF SMALL SCALE COMPANY

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd