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FRM Part I · FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009

A CDO has collateral with a total notional of 1,000 million. The equity tranche absorbs the first 5% of losses, the mezzanine tranche the next 15% (5% to 20%), and the senior tranche the remainder. If collateral losses reach 14% of notional, what are the losses borne by the mezzanine tranche and the senior tranche respectively?

Total collateral losses are 140 million. The equity tranche absorbs the first 50 million, leaving 90 million for the mezzanine tranche, which has capacity of 150 million. The senior tranche is untouched, so losses are 90 million mezzanine and zero senior.

  1. A90 million and 0Correct
  2. B140 million and 0
  3. C90 million and 50 million
  4. D40 million and 100 million

Explanation

Total loss is 140 million. Equity absorbs the first 50 million (5%). The remaining 90 million falls in the mezzanine range, which can absorb up to 150 million (15% of 1,000), so mezzanine loses 90 million and the senior tranche loses 0. Check: 50+90=140. Option 2 ignores the equity tranche.

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