FRM Part II · FRM Exam Part II · Credit Derivatives
A CDO tranche attaches at 3% and detaches at 7% of a 500 million portfolio. Cumulative portfolio losses reach 5.0% (25 million) with no recoveries beyond those already netted. What percentage of the tranche's notional has been lost?
The tranche has lost 50% of its notional. Its size is 4% of 500 million, or 20 million. Portfolio losses of 5% exceed the 3% attachment by 2%, which is 10 million, and 10 million divided by 20 million is 50%.
- A50%Correct
- B40%
- C71%
- D29%
Explanation
Tranche notional = 4% of 500 million = 20 million. Loss to the tranche = portfolio loss above the 3% attachment point = 5% - 3% = 2% of 500 million = 10 million. Loss share = 10/20 = 50%. The 40% option divides by 25 million, the portfolio loss. The 71% option uses 5/7. The 29% option uses 2/7.
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