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Structured Finance and the Financial Turmoil of 2007 2008

Securities mbs commercial bank a that provides

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securities (MBS) Commercial bank A that provides liquidity support Commercial bank B that provides liquidity support Ultimate investors Fee Liquidity Cas h ABCP Channel 1: Creation of MBS. Channel 2: Creation of CDOs. US investment bank Collateralized Debt Obligations (CDOs) German bank Channel 3: US investment bank needs to absorb unsold CDO’s on its balance sheet. Channel 4: German bank sells assets and/or debt to its SIV. Cash Assets and/or debt of German bank Assets absorbed by German bank Cash Channel 5: German bank absorbs SIV assets on its balance sheet. Channel 6: Liquidity support. SOURCE: Own elaboration .
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Annex 1: Overview of CDS index contracts In addition to the CDX.NA.IG and iTraxx Europe index contracts, numerous other contracts exist (see Table 5). For example, other contracts are based on diversified high yield portfolios of 100 names (CDX.NA.HY) and on subse ts o f 10 -30 names o f sector portfolios and sub-investment grade portfolios (CDX.NA.HY.B, CDX.NA.HY.BB, CDX.NA.HY.BBB). The iTraxx HiVol index is based on a subset of the main investment grade index consisting of what are seen as the most risky 30 constituents at the time the index is constructed. The iTraxx Crossover index is constructed in a similar way, but is composed of 30 sub-investment grade credits that consist of the most liquid non-financial companies rated BBB/Baa3 or lower, thus mainly junk or below-investment grade status, and on negative outlook. All names in these indices are equally weighted and contracts with 3, 5, 7 and 10 year maturities are available. Recently, three new different types of CDS index contracts have appeared which belong to the CDX and iTraxx families, but which are different in terms of the underlying debt (see Table 5). The CDX.EM index is based on CDS contracts with as underlying debt instruments the sovereign bonds issued by 14 emerging market economies, while the CDX.EM. “diversified” index (in yellow in Table 5) comprises exposure to 20 CDS of both sovereign and corporate debt instruments of emerging market economies. The LCDX and LevX indexes track CDS over a pool of respectively 100 and 35 specific leveraged loans in North America and Europe. The emergence of structured products has resulted in the introduction of related CDS index contracts in North America, which are the ABX.HE, TABX and CMBX index contracts (see Table 5). The ABX.HE (i.e. “Asset Backed IndeX of Home Equity”) is a CDS index contract launched in January 2006 based on 20 recently issued US sub-prime residential mortgage-backed securities (i.e. subprime residential mortgage-backed securities or RMBS). The TABX is a CDS index contract based on tranches of the ABX.HE. Finally, the CMBX is a CDS index contract launched in March 2006 referenced on 25 commercial mortgage securitizations (CMBS) [see IMF (2008)].
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