Financial Times' Alphaville has created a toy model to demystify collateralised debt obligations, addressing a gap in their recent 4,000-word credit explainer that omitted securitisation entirely. The synthetic CDO model demonstrates how these instruments work using credit default swaps on 20 investment-grade companies with $1 billion notional exposure. This educational tool comes as securitisation remains a massive $10 trillion market in US dollars alone.

Alphaville's model shows how these structures function as simple companies holding income-producing assets. The CWO (Collateralised Whatever Obligation) sells five-year credit insurance, generating $12.3 million annually. The structure uses tranched backstops where equity investors receive $9.7 million yearly for accepting first losses on less than 5% of notional exposure. Meanwhile, super-senior investors get $1.8 million annually but only face losses after nearly a quarter of the portfolio defaults.

Historical data shows investment-grade defaults have been so rare that super-senior investors might view their payments as mere perks. The model illustrates how securitisation can transform lower-rated assets into highly rated securities through subordination. This financial engineering allows pretty much any regular cash flow - from bonds to David Bowie's royalties - to be repackaged into new debt instruments, though critics argue this creates unnecessary complexity.