What does leverage mean in CDO? if i buy mezzanine tranche, is the leverage larger than senior tranche? is it total portfolio size divided by tranche size?Is AAA tranche on synthetic CDO on 75%ABS/25%CDO safe for investment? is it good deal at L+85bp with cross-subordination in inner CDOs? However, the deal does not provide fixed recovery rate for CDO portion, only 90% for ABS portion. Most of the time, the rating doesn't truthfully reflect the credit spread, sometimes the worst rating can have tighten spread than good rating.Hope you can enlighten me in these issues. Thanks

usually leverage is used to describe the amount of leverage in the equity tranche versus the portfolio size. ie a cdo w/ 1bn investment grade portfolio w/ a 20mio equity strip, would be 50 x leveraged. regarding "safe" to invest, it depends on what you mean by safe. Are you more concerned about repayment risk or mark to market movements? repayment risk on the AAA tranches are fairly low (as the rating would imply), however AAA tranches sometimes themselves contain leverage (through a super senior tranche) or the portfolio of the cdo might be leveraged loans or high yield which is more sensative to spread risk. so chances are you'll have more spread vol on the AAA tranche of a CDO compared to a AAA corp or sovr credit. Also most of the time these 'mixed' asset deals, which have x% ABS and 1-x% CDO's, leveraged loans, etc. are a way for banks to repackage crap (1-x%) into something that looks sexy due to the ABS component. however due to the leverage of these deals, even if the non-ABS deal is only 10% of the portfolio, it can seriously impact the portfolio. If you are looking at a structure like this, make sure you know and are comforatable with the non-abs piece of the portfolio, as this is usually that piece that makes these structures come apart.

so if the senior tranche is 1,800 mio, class I tranche is 100 mio, the whole portfolio is 2,400 mio. the leverage of class I tranche will be 1800/100?for CDO on ABS/CDO, assuming no ABS defaults, once one of the inner CDO tranche is totally eroded, does it mean the AAA-tranche in master level will be eroded most of the time?

leverage would be 2400/100, or 24:1 on the I tranche. regarding capital structure erosion really depends how many cdo's are in the portfolio and how much one of them will impact the portfolio. also depends on when it happens, since that will effect the waterfall. One would have to simulate the cdo to really quantify the impact on the various tranches in the capital structure. a cdo holding gone bad, could easilyl wipe out the equity tranche though.

What is the common tools for analyzing CDO or CDO^2?Monte Carlo, KMV, CreditMetrics??? should we consider correlation factor as well?

KMV has a CDO Analyzer, which is a multi-step MC simulation tool.NumeriX is playing big in the Structured Credit space. They have a Credit Engine to price and perform risk analysis on secondary deals.N

Modeling correlation between underlyings off course would be the key. There's a ton of work going on in establishing parsimonious modeling method (different flavours of it).

are CDO Analyzer, CDO Evalutor, NumeriX expensive products? the costs?

Numerix is not as costly as the other rating agency products (CDO analyzer by Moody'sKMV and Evaluator by S&P), however it might not be as exhaustive either. I don't have the license cost. You have to pick up the phone.N

Cdo Evaluator and Fitch Vector Model are free, I'm looking for the cost of CDO analyzer

CDO Evaluator and Fitch Vector are free, where can I get?