FRM Part II · FRM Exam Part II · Credit Derivatives
A CDO tranche has an attachment point of 3% and a detachment point of 10% on a reference portfolio of notional USD 1,000 million. Cumulative portfolio losses reach USD 55 million. What is the loss borne by the tranche, and the percentage of the tranche notional written down?
The tranche absorbs USD 25 million, a 35.7% write-down. The tranche spans USD 30 million to USD 100 million, so its notional is USD 70 million. Losses of USD 55 million exceed the attachment point by USD 25 million, and 25 divided by 70 gives 35.7%.
- AUSD 25 million; 35.7%Correct
- BUSD 55 million; 78.6%
- CUSD 52 million; 74.3%
- DUSD 25 million; 83.3%
Explanation
Tranche covers USD 30m to USD 100m, so notional is USD 70m. Portfolio loss of USD 55m exceeds the attachment of USD 30m by USD 25m, which is below the 70m width. Write-down is 25/70 = 35.7%. Option 3 divides by 30 (attachment) instead of the tranche width.
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