Credit Suisse First Boston is planning to roll out a string of collateralized debt obligations of pure equity-default swaps, a rare structure that many derivatives houses have dismissed as a novelty. The firm hit the road last month with CEDO II, a follow-up to April's CEDO I, which Stephane Diederich, managing director in equity derivatives at CSFB in London, said marked the beginning of a new product line for the firm. "We expect to launch follow-up deals off the CEDO product for some time to come," he said. The transaction is being shown to insurers, pension funds and proprietary desks in Asia and has roused market buzz about the quiescent EDS sector.
Pure EDS CDOs have largely been bypassed by the dealer community because of problems offloading the risk of illiquid EDS, which are essentially deep out-of-the-money put options. Diederich said the long/short underlying portfolios of CEDO II, which comprise 112 EDS and offer an attractive spread pick-up and diversification versus traditional CDOs, have been hedged by CSFB using equity options. "All 112 single stocks over the six years have been hedged in the market," he said. He declined to specify pricing.
In the six-year static transaction an equity event, which triggers payment from CSFB to investors, is defined as a drop in an underlying entity's share price of 35%. Investors are protected from distressed equity events during the first three years and recovery upon default is not fixed. Five classes of notes will be issued when the CDO closes on Dec. 2 and have been rated from Aaa to Baa2 by Moody's Investors Service.
