A note or bond or tranches of notes and/or bonds that an SPV (q.v.) issues,
in order to raise money to buy mortgage loans that serve as collateral for the note(s).
Application: The CMO gets the bonds off the balance sheet of the CMO’s creator,
thus eliminating credit exposure, in return for cash, and allows the creator to structure collateral and notes to provide the desired credit rating.
Comment: The REMIC (q.v.) has replaced the CMO as the vehicle of choice for repackaging mortgage loans and getting them off a mortgage lender’s balance sheet.

A note or bond or tranches of notes and/or bonds that an SPV (q.v.) issues,
in order to raise money to buy loans that serve as collateral for the SPV obligations.
Application: The CLO gets the loans and attendant exposure off the balance sheet of the SPV’s creator,
in return for cash, and allows the creator to structure collateral and SPV obligations to provide the desired credit rating.

A note or bond or tranches of notes and/or bonds that an SPV (q.v.) issues, in order to raise money to buy bonds that serve as collateral for the SPV obligations.
Application: The CBO gets the bonds off the balance sheet of the SPV’s creator, in return for cash, and allows the creator to structure collateral and SPV obligations to provide the desired credit rating.

Chase Bank’s preferred vehicle for transferring a large amount of diverse credit risk into an SPV.

An insurance contract that promises the bondholder a payment (maybe not payment in full) in case the debtor defaults.

A contract that puts the guarantor in place of the debtor, in case of debtor’s default. Thus, a guarantee seems to promise payment in full of the bond’s interest and principal and is like bond insurance (q.v.) that pays off enough to make the borrower whole. Of course, we have to ask, “Who guarantees the guarantor?”

Definition: An acronym for either of the following, depending on who’s talking and who might be listening.
1. Broad Index Secured Trust Offering. J.P.Morgan’s preferred vehicle for transferring a significant amount of diverse credit risk to an SPV.
2. BIS Total Rip Off. An alternative definition of unknown meaning.

The purchase of a fixed rate instrument, plus a position of paying fixed and receiving floating in an interest rate swap of the same maturity.
A dealer ordinarily arranges both the sale and the swap.
Example: An investor who wants to buy Freddie Mac debt with a floating coupon might buy Freddie Mac’s fixed rate debt and pay fixed in an interest rate swap.
Application: The main reason for doing an asset swap is to tailor a bond’s coupon stream to fit one’s needs,
namely to convert a fixed coupon stream into a floating stream.
Pricing: The asset swap should trade at roughly the cost of the underlying fixed rate instrument,
because the interest rate swap should have zero value at inception.
Risk Management: The asset swap is a tool for converting from the risk of price fluctuations to the risk of payment fluctuations,
since the value of default riskless floating rate debt reverts to par at each reset debt.
Comment: Asset swap spreads are useful for pricing credit default swaps.

A swap that imitates the characteristics of a superfloater bond in exchange for paying a fixed rate, the counterparty receives a multiple of Libor minus a constant.
Example
A floating rate borrower wishes not just to protect itself against expected rate rises but actively to benefit from them.
It enters a superfloater swap in which it pays fixed and receives Libor as long as floating rates stay between an upper and lower strike rate struck on either side of the fixed rate payable.
In a two-times multiplier superfloater for every basis point above the upper strike rate that floating rates rise, the borrower receives two basis points of floating rate payment.
If the floating rate falls below the lower strike then the floating rate multiplier paid to the borrower falls at a predetermined rate.
So the borrower’s effective fixed-rate under the swap increases as rates fall below the lower strike band but decreases as rates increase above the upper strike level.
The borrower has bought a cap and sold a floor.
Swap differential/difference agreement (SDA)
An interest rate basis swap contract to exchange or lock in the differential between a bond or note yield and the swap rate of the same maturity.
The contract moves with reference to the difference between the same point on the two different yield curves.
It allows an investor to profit from the widening or narrowing between two yield curves.
The SDA is customized with defined settlement dates, a defined value per basis point move, and one defined point on two yield curves.
All payments are made in one currency so there is no currency exposure.
Example
An investor might believe that the differential between the two-year Euro swap rate and the two-year Swiss franc swap rate will narrow over the next year.
The investor enters a narrowing Euro-Swiss franc SDA for one-year settlement.
The value per point can be set at any value in either currency, say Sfr10,000
The SDA price is given in terms of basis points.
If at maturity the difference between the two-year swap rates in the two currencies has fallen below the SDA entry level, the investor will receive Sfr10,000 for every basis point lower.
If the difference is higher than the entry level the curves have widened the investor will lose this amount.
The entry price is calculated by taking the difference between the implied forward rates from the two yield curves.
In the example, the one-year forward two-year Euro and Swiss franc rates are calculated and the difference is the SDA price.
Investors who buy the SDA expect curves to widen; those who sell expect curves to narrow.

A swap that pays a fixed-rate below the market rate.
However, if rates rise above a certain trigger level, the fixed-rate payer will pay a floating rate minus a spread determined by the then prevailing floating rate.
The result is a below market fixed swap that reverts to a below market floating rate swap when the trigger is hit.
The subsidized swap is the combination of a pay-fixed swap and the sale of a cap.
The cap premium is used to reduce the fixed rate paid under the swap.
Also known as a subsidized swap.
Example
The sale of a five-year sterling cap at 10.60% will earn the seller 50bp semi-annually.
This amount improves the five-year swap rate from 8.83% to 8.33%.
If sterling Libor exceeds 10.60%, the client will be put back into floating at a subsidized rate of Libor less 2.27%.
The instrument is ideal for borrowers who want to lock in their floating rate, but do not want to pay the market rate as they believe the implied forward curve significantly overstates future rate rise.
It generates an attractive fixed rate as long as their rate ceiling is not breached.
And even if it is, they still do better than competitors paying vanilla floating rates.