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FRM Part II · FRM Exam Part II · Credit Risk

A CDO pool has a notional of USD 1,000 million. The equity tranche covers losses from 0% to 5%, the mezzanine tranche from 5% to 15%, and the senior tranche above 15%. Pool losses of 12% occur. What are the losses suffered by the mezzanine tranche, as a percentage of mezzanine tranche notional, and by the senior tranche?

Mezzanine loses 70 percent of its notional and senior loses nothing. Pool loss is 120 million; equity absorbs the first 50 million, leaving 70 million against a 100 million mezzanine tranche. The senior tranche attaches at 150 million of losses, which is not reached.

  1. A70% of mezzanine notional; senior nothingCorrect
  2. B12% of mezzanine notional; senior nothing
  3. C70% of mezzanine notional; senior USD 30 million
  4. D100% of mezzanine notional; senior nothing

Explanation

Pool loss is USD 120m. Equity absorbs the first USD 50m. The remaining USD 70m falls on mezzanine, whose notional is USD 100m (5% to 15%), a 70% loss. Senior attaches at 15% (USD 150m) and so loses nothing. Using 12% directly ignores subordination; 100% ignores the attachment structure.

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