From the perspective of a CDO manager, an arbitrage collateralized debt obligation most likely differs from a traditional asset-backed security because it involves the:
- pooling of debt obligations.
- active management of the collateral.
- creation of a special purpose entity.
Solution
2 is correct.
PLease explain why 2 is correct. why not 1.
I think agar question mai sidha difference puchte tho answer option A b ho sakta tha
Lekin arbitrage CDO pucha h tho option B correct hai because arbitrage karne ke liye active management hi karna padega
May be this could be the reason
Look Shurti technically CDO is not an ABS bocz in ABS the funds required to pay the security holder are generated by the asset pool. However in CDO the manager actively trades to pay off the CDO holder. Now CDO has 3 tranches senior mezzanine & subordinate or equity which is held by the spv only. Now the equity tranch raises low cost funding by issuing the other 2 tranches & then those funds are used to buy portfolio of debt obligations and the actively managed to generate a mistakenly called arbitrage return i.e return in excess of funding cost. This excess goes to the CDO manager & the rest is taken by the equity tranch. The success of the entire CDO depends on the earning competitive return for the equity tranch.
Now if they don’t manage it actively they will only earn the return for the 1st 2 tranches. And it is mistakenly called arbitrage it’s actually earning return in excess of funding cost if they don’t manage actively they will not able to earn it.