FRM Part II · FRM Exam Part II · Structured Credit Risk
A $1,000 million pool has a mezzanine tranche with attachment point 5% and detachment point 15%. The pool experiences a cumulative loss of 11%, with no recoveries or excess spread. What is the loss to the mezzanine tranche, as a percentage of the tranche's principal?
The mezzanine tranche loses 60% of its principal. The first 5% of pool losses is absorbed by the equity below, so the tranche takes 6% of the pool, or $60 million, against a tranche size of $100 million. Pool loss of 11% is not the tranche loss because of the attachment point.
- A11%
- B40%
- C60%Correct
- D100%
Explanation
Tranche loss starts at 5% of the pool. Pool loss of 11% means the tranche absorbs 11% - 5% = 6% of pool, i.e. $60 million. Tranche size is 10% of pool ($100 million), so the loss is 60/100 = 60%. Using 40% would be the remaining unimpaired portion, and 11% ignores the attachment point.
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