Collateralized Debt Obligation: The Lehman Brothers Case Study

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Letter of Transmittal
3/82 Wellington Rd
Clayton, Vic 3168
September 6, 2012

Dr. Mohammad Hoque
Department of Accounting and Finance
Monash University
PO Box 197
Caulfield East, Vic. 3145

Dear Mr. Mohammad Hoque:

Enclosed is a copy of “Group Assignment” about the understanding of CDOs. This report is aim to critically examined how CDOs may help banks to avoid liquidity risk and create more assets, and also problems in term of the purpose of CDOs, the role of three mechanisms in CDOs and problems faced in CDOs. After that, it discusses how CDOs created problem for Lehman Brothers by analysis subprime mortgage crisis. Finally, this report provides some recommendations for making the CDOs as effective liquidity risk
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Secondly, this report will provide an example – the Lehman Brothers which was involved in CDOs and give that how CDOs created problems in it and finally let Lehman Brothers bankrupt. Last, this paper will provide four recommendations for making the CDOs as effective liquidity risk management mechanism for banks or financial institutions. All these four recommendations need government, banks and financial institutions corporate. Finally, this report will give a conclusion that emphasizes the analysis and evaluation of CDOs in this paper.

Main Body:
The Purpose of CDOs
Collateralised Debt Obligations, short for CDOs, is an important part of asset securitisation. CDOs provided more liquidity in the economy which was a popular financial innovation. It is an innovative financial product that repackages different debts into a new portfolio. In CDOs, investment bank gathered a series of assets from the fixed-income market, such as mortgage-backed securities, credit-default swaps, and high-yield bonds. Once the CDO has created by the investment bank, it would distribute the cash flows from those mentioned assets to investors in the CDO. CDOs pool all the cash flows from its collection of assets together and divided into rated tranches or slices, in order to satisfy the needs of different risk preferences of investors. Suppose there are three basic tranches, safe, good enough and risky. When money comes in, the top one will be filled in first. It

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