Synthetic CDO Structure: One More Wrinkle

Synthetic CDOs can be structured as funded or unfunded.  In a funded CDO, the investors buy securities from the manager who buys Treasury notes.  The manager receives swap payments from selling credit default swaps (CDS) and the interest on the notes.  These are passed on to the investors as interest on the CDO securities.  If a credit event happens on the CDS position, the CDO has to pay out based on the terms of the contract.  The notes are sold to cover this cost.  In an unfunded CDO, investors become the seller of the CDS position.  They receive payments from the CDS position and are liable for any payouts in case of a credit event.  The CDO is paid a management fee.