Question

What is a CMO and what risks are they designed to manage? What is a CDO? How did CDOs transform weak-credit subprime mortgages into high quality securities? Why was this process an essential step in the development of the financial crisis? How did credit default swaps amplify the crisis?

Answer 1

Collateralized mortgage obligation refers to mortgage backed securities that will be constituting of packaged mortgage organised according to the risk profiles. These are are debt obligations which are collection of of mortgages and they will be trying to roll out various kinds of debt securities which will be having mortgages at their underlying securities.

They are designed to manage the the risk of liquidity because they are trying to infuse liquidity into the system and they can also generate cash and short term money by floating out this assets which are backed by mortgage

Collateralized debt obligation means the debt obligation which is backed by pool of loans and other Assets and it is similar like collateralized mortgage application but it will be having other type of debt as underlying assets.

collateralized debt obligation will be pooling up weak securities and they will be floating them together in order to pose as high-quality securities and this will be attracting a lot of investor to invest their money into the securities so they will be e bundling the good quality debt with the bad quality debt and they will be showing them as high-quality securities.

this was leading to an essential step in development of financial crisis because they were setting up the platform for liquidation of those assets which provided bad quality loans and when bad quality loans were redeemed, it would lead to to decrease in the Asset Value of multiple companies and which will lead into faltering by these companies due to fall in the value of the debt security which were backed by bad assets.

Credit default swaps Where are acting as a financial derivatives, which were providing tradibility to these securities which were backed by the housing Assets and it was written off by multiple insurance companies and investment bankers so when borrowers started to default, then it lead to a series of defaulting by these organisations and that had amplified the crisis.