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CFA Level I · CFA Level I Exam · Asset-Backed Security (ABS) Instrument and Market Features

A CDO has total collateral of 200 million with an equity tranche of 20 million, a mezzanine tranche of 60 million and a senior tranche of 120 million. Cumulative collateral losses are 50 million, allocated by the standard waterfall. The mezzanine tranche's loss as a percentage of its original size is closest to:

The mezzanine tranche loses about 50% of its original value. The equity tranche absorbs the first 20 million of the 50 million loss, leaving 30 million for the 60 million mezzanine tranche, which is 50%, while the senior tranche is untouched.

  1. A0%
  2. B50%Correct
  3. C100%

Explanation

The equity tranche absorbs the first 20 million. The remaining 30 million falls on the mezzanine tranche, which is 30/60 = 50% of its size. The senior tranche is unaffected. Counting the full 50 million as mezzanine loss would give over 100%, which is wrong because equity takes the first 20 million.

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