FRM Part I · FRM Exam Part I · Banks
A bank wants to securitize a pool of mortgages and retain an economic interest in it to align incentives with investors. Which action best achieves this?
The bank should retain a portion of the first-loss equity tranche. Because that tranche absorbs losses first, the originator keeps meaningful exposure to loan quality, which aligns its incentives with investors. Selling every tranche or fully hedging the pool would remove its exposure.
- ARetaining a portion of the first-loss (equity) trancheCorrect
- BSelling every tranche to outside investors at par
- CBuying credit protection on the full pool from a third party
- DMoving the SPV's servicing to an unrelated firm
Explanation
Holding part of the first-loss tranche means the originator bears the earliest losses, giving it a stake in loan quality ('skin in the game'). Selling all tranches or hedging the full pool removes exposure, and changing the servicer does not create retained risk.
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