Constant proportion debt obligation

A Constant proportion debt obligation (CPDO) is a type of credit derivative sold to investors looking for exposure to credit risk. A CPDO is normally embedded in a note rated by a credit rating agency. CPDOs employ dynamic leveraging in a similar (but opposite) way to Credit CPPI trades.

CPDOs are formed first by creating a SPV that issues a debt note. The SPV invests in an index of debt securities, commonly credit default swap indices such as CDX and iTraxx (in theory, this could be deal-specific, such as a bespoke portfolio of sovereign debt), similar to a CDO. The structure allows for continual adjustment of leverage such that the asset and liability spreads stay matched. In general this involves increasing leverage as when losses are taken, similar to a doubling strategy, in which one doubles one's bet at each coin toss until a win occurs.

The investment index is periodically rolled, whereby the SPV must sell protection on the new index and buy back protection on the old index. In doing so, it incurs rollover risk, in that the leaving index may by priced much wider than the new index.