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Derivatives

CDO Equity Offers Attractive Returns

CDO equity compares favorably to other fixed income, equity and hedge fund assets, according to a study by Merrill Lynch.

CDO equity compares favorably to other fixed income, equity and hedge fund assets, according to a study by Merrill Lynch. Chris Ricciardi, managing director, said the firm compiled data on 80 CDO equity tranches and compared their performance and correlation against various indices. These included treasury, ABS, high-yield and leveraged loan indices, equity indices including the Standard & Poor's 500, Dow Jones Industrial Average and the CSFB Tremont Hedge Fund index. It also found that equity tranches offered attractive returns on both an absolute and risk-adjusted basis, while also not exhibiting significant correlation to other assets, he said.

Merrill found that ABS equity tranches generally move in the direction of fixed income indices, but in reverse to equity and leveraged loan indices and determined that these correlations are not significant. The firm further found that ABS equity tranches are less sensitive than mortgages to interest rate changes. CLO equity returns, meanwhile, moved in the direction of leveraged loan, equity and hedge fund indices, although the only significant correlation was with the latter.

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