ABSTRACT
An investor in a CDO squared would need to read in excess of 1 billion pages to understand fully the ingredients.2
Whether or not the Bank of England Executive Director of Financial Stability is correct that proper due diligence on a collateralized debt obligation (CDO) squared is reading and understanding one billion pages, his observation confirms that credit derivatives are complex, and the documentation is extensive, opaque, and often incomprehensible. The capacity to fully understand derivatives products requires considerably more expertise and due diligence than was evident prior to the 20082009 global financial crisis. Derivatives and other structured financial product contracts are beyond the capacity of many investors, in terms of appreciating the complexity and the risks associated with the products. Yet derivatives have become a significant factor in the financial landscape. They have an important role in managing risk associated with direct investment under lending portfolios. However, that original objective of managing portfolio risk was overtaken by a speculative market for buying and selling credit derivatives in multiples of the value of the underlying reference entity.3
