What is Bespoke CDO?

Definition

Bespoke CDO (Collateralized Debt Obligation) is a type of structured financial product, specifically composed of CDOs, created by dealers for a specific group of investors and tailored to their needs. The investor group typically purchases a single tranche of the bespoke CDO, while the remaining tranches are held by the dealer. Dealers often attempt to hedge potential losses using other financial products such as credit derivatives.

Origin

Bespoke CDOs originated in the late 1990s and early 2000s when there was an increasing demand for complex structured products in the financial markets. These products were developed to meet specific investors' risk preferences and return objectives, particularly during the boom of the subprime mortgage market.

Categories and Features

Bespoke CDOs can be categorized based on the type of underlying assets and risk tranches. Typically, these securities include tranches of varying risk levels, from senior to subordinate. Senior tranches have lower risk and lower returns, while subordinate tranches have higher risk and higher returns. Their main features are flexibility and customization, allowing adjustments to meet specific investor needs.

Case Studies

Before the 2008 financial crisis, many financial institutions like Lehman Brothers and Bear Stearns were involved in the creation and trading of bespoke CDOs. The complexity and lack of transparency of these products were considered significant factors in the crisis. Another example is Goldman Sachs, which continued to offer bespoke CDOs to specific clients after the crisis to meet their particular investment needs.

Common Issues

Common issues investors might face when using bespoke CDOs include the complexity and lack of transparency of the products, which can lead to misjudgment of risks. Additionally, insufficient market liquidity may make it difficult to sell these securities when needed.