These hedge funds were forced into bankruptcy. This was due to:

the correct answer is:

Long Mezzanine and Short Equity Tranche position when correlation of Mezzanine tranche decreased.

Can anyone explain the above?

Specifically what is spread and how it affects value of Equity tranche? And why the above situation led to losses?

  • 1
    $\begingroup$ As a CDO investor you face both "credit spread risk" resulting from changes in the creditworthiness of the underlying credits, as well as "default risk" from the actual default of those entities. In May 2005 Ford and General Motors did not default, but their credit rating was downgraded. $\endgroup$ – Alex C Mar 13 '16 at 2:06

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