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FRM Part II · FRM Exam Part II · An Introduction to Securitisation

A bank enters a synthetic securitisation of a reference portfolio of USD 1,000 million. The first-loss tranche covers losses from 0% to 3%, the mezzanine tranche from 3% to 10%, and the senior tranche covers above 10%. The bank retains the first-loss tranche and the senior tranche and sells mezzanine protection. Portfolio losses at the end of the term are USD 65 million. What loss does the bank bear on its retained positions, and what loss is borne by the mezzanine protection seller?

The bank bears USD 30 million and the mezzanine protection seller bears USD 35 million. The first 3% of the pool, USD 30 million, is absorbed by the retained first-loss tranche; the remaining USD 35 million sits within the USD 70 million mezzanine tranche, so the senior tranche is untouched.

  1. ABank USD 30 million; mezzanine seller USD 35 millionCorrect
  2. BBank USD 65 million; mezzanine seller USD 0
  3. CBank USD 35 million; mezzanine seller USD 30 million
  4. DBank USD 30 million; mezzanine seller USD 65 million

Explanation

First loss is 3% of 1,000 = USD 30 million, borne by the bank. Remaining losses of 65 - 30 = USD 35 million fall in the mezzanine tranche, whose size is 7% x 1,000 = USD 70 million, so it is not exhausted. Senior is untouched. Check: 30 + 35 = 65.

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