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The market for collateralized debt obligations, or CDOs, is the fastest-growing business on Wall Street.

Banks create CDOs by bundling together assets ranging from mortgages to loans to high-yield bonds, with income from those assets used to repay investors. The securities are divided into pieces, or tranches, that can offer yields as high as 14 percent, said Nestor Dominguez, 48, co-head of Citigroup's North American CDO group in New York. Average investment-grade bonds yield 5.1 percent and junk bonds yield 7.5 percent, according to Merrill.

``The high yields have created great demand for CDOs from hedge fund managers and arbitrageurs,'' said Thomas Eggenschwiler, 47, co-head of fixed-income research at Aladdin Capital Management LLC in Stamford, Connecticut, which oversees about $3.5 billion and buys the securities.

CDO fees usually equal about 1.5 percent to 1.75 percent of the size of a deal, bankers who arrange such sales say. That's more than triple the average 0.4 percent that banks charge to sell investment-grade bonds and about the same as fees on junk bonds, traditionally the most lucrative, Bloomberg data show.

Many CDOs are “synthetic,” meaning they’re backed by credit default swaps. Although Greenspan has spoken favorably of credit default swaps, the growth of this market has led to meeting to a meeting of top Wall Street firms next month at the New York Fed to discuss credit derivatives.

Posted by edelfenbein at August 30, 2005 9:53 AM