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

A bank holds a $200 million pool of loans with an 8% capital requirement and an average risk weight of 100%. It securitises the pool and retains only the first-loss tranche of $6 million, which is deducted from capital (equivalent to a 1,250% risk weight). All other tranches are sold with significant risk transfer achieved. Ignoring other effects, what is the approximate reduction in required capital from the securitisation?

The saving is about $10 million. Capital before is $200 million times 100% times 8%, which is $16 million. After securitisation the bank deducts the $6 million retained first-loss tranche, leaving $6 million of capital, so the reduction is $10 million.

  1. A$16.0 million
  2. B$10.0 millionCorrect
  3. C$6.0 million
  4. D$1.0 million

Explanation

Capital before is 200 x 100% x 8% = $16 million. After the transaction, the retained first-loss tranche of $6 million is deducted, so the capital held against it is $6 million. The reduction is 16 - 6 = $10 million. Choosing $16 million ignores the retained tranche; choosing $6 million confuses the remaining capital with the saving.

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