1. Elasticity
Elasticity measures how much quantity changes when price changes. It’s the percentage change in quantity divided by the percentage change in price. If a 10% price rise cuts quantity by 20%, elasticity is −2. Absolute values above 1 mean elastic (flat curve, large quantity shift), below 1 mean inelastic (steep curve, small quantity shift).
Demand elasticity depends on how easily consumers adjust. Goods with close substitutes or that aren’t essential—like soft drinks or brand names—are elastic. Necessities like insulin or electricity are inelastic because people can’t reduce use much even if price rises.
Supply elasticity depends on how easily producers can expand. In the short run, capacity and resources are fixed, so supply is inelastic; in the long run, firms can add plants or enter the market, making it elastic.
Elasticity determines who bears a tax mechanically. When demand is inelastic, buyers barely change quantity, so sellers can raise prices almost fully to pass the tax on. When demand is elastic, buyers reduce purchases sharply, forcing sellers to absorb most of the tax in lower net prices. The side of the market that reacts less—more inelastic—ends up carrying more of the burden.
2. CLOs
Banks originate leveraged loans—typically to finance buyouts or refinancings—and syndicate them to institutional investors. A CLO manager doesn’t originate; it buys these loans, building a diversified portfolio under strict tests for credit quality, industry mix, spread, and maturity. The end goal is to package the pool into a long-term, levered structure that slices the credit risk into tranches.
Because the manager can’t buy $500 million of loans overnight, it first opens a warehouse with an arranger bank. The warehouse provides short-term senior financing, usually about 4× leverage (e.g., $100 million of equity and $400 million of credit). This lets the manager accumulate loans gradually. The warehouse is mark-to-market: if loan prices fall or credit quality weakens, the bank can demand margin or force asset sales. It’s a risk-controlled bridge, not permanent funding.
Once the portfolio is fully ramped and market conditions are favorable, the manager closes the CLO. The loans are sold into a special-purpose vehicle that issues long-term tranches—typically about $440 million of rated debt (AAA through BB) and $60 million of equity. The proceeds pay off the warehouse lender. The equity investors roll their capital into the new CLO, though the nominal amount may fall because the structure can now run higher leverage—7–8× instead of 4×—thanks to stable, term financing and no mark-to-market risk.
The CLO’s loans yield around 10%, while its weighted funding cost across tranches is roughly 7%, leaving a 3% net spread. After management and admin fees (~0.5%), that’s about 2.5% excess spread on $500 million of assets—around $12–13 million annually flowing to the equity. On $60 million of equity, that’s roughly a 20% return, assuming credit losses stay low.