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Derivatives

Third Generation Of CDOs Squared Emerge

Morgan Stanley and Tricadia CDO Management have priced a USD400 million synthetic collateralized debt obligation squared, using credit-default swaps to reference collateralized loan obligations and CDOs of asset-backed securities.

Morgan Stanley and Tricadia CDO Management have priced a USD400 million synthetic collateralized debt obligation squared, using credit-default swaps to reference collateralized loan obligations and CDOs of asset-backed securities. Similar deals have recently used total-return swaps, but this deal, called Tricadia 2006-5, appears to be the first of as many as 15 CDOs squared now ramping to use CDS. Officials at Morgan Stanley and Tricadia declined comment.

The structures are the third and potentially most stable generation of CDOs squared. In their first incarnations, CDOs squared were re-securitizations of cash CDOs. More recently, they were synthetic deals referencing hypothetical synthetic corporate CDO tranches. But the synthetic version nearly disappeared last year when credit correlation turmoil, sparked by auto downgrades, hurt deal economics and made investors skeptical of highly structured credit investments, explainedMichiko Whetten, a quantitative credit analyst in U.S. fixed-income research at Nomura Securities in New York.

This third generation is a boiled-down mix of the two: the first layer is cash and the second is a swap. Dealers, CDO managers and ratings analysts are attributing the renewed interest in CDOs squared to the creation of standardized documentation for CDS on CDOs from the International Swaps and Derivatives Association.

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