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Lex: leverage in the credit market
The demand for constant proportion debt obligations - which take credit default swap exposure and apply leverage to boost returns - is symptomatic of investors’ quest for yield, almost irrespective of risk, in a low-return world still awash with easy credit, writes Lex
That appetite has driven the cost of protection on the iTraxx and the comparable US index to fresh lows.
If everything goes smoothly, leverage on CPDOs falls as the instrument accumulates excess returns. But the reverse is also true - and in the case of losses, because of unexpected defaults or a worsening credit outlook, leverage can rise, up to cap, in an effort to “win back” any shortfall.
Any turn in the credit cycle could leave yield-hungry CPDO investors wishing they hadn’t been so quick to consume.
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[…] Add:07/11/2006 , Lex [FT Alphaville] chips in with its 2 cents: The demand for constant proportion debt obligations - which take credit default swap exposure and apply leverage to boost returns - is symptomatic of investors’ quest for yield, almost irrespective of risk, in a low-return world still awash with easy credit, writes Lex [1] That appetite has driven the cost of protection on the iTraxx and the comparable US index to fresh lows. If everything goes smoothly, leverage on CPDOs falls as the instrument accumulates excess returns. But the reverse is also true - and in the case of losses, because of unexpected defaults or a worsening credit outlook, leverage can rise, up to cap, in an effort to “win back” any shortfall. Any turn in the credit cycle could leave yield-hungry CPDO investors wishing they hadn’t been so quick to consume. [1] CPDOs/leverage […]