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FRM Part II · FRM Exam Part II · An Introduction to Securitisation

A CLO holds a $500 million loan pool. Tranches: senior $350 million, mezzanine $100 million, equity $50 million. Losses are absorbed from the bottom up. If pool losses over the period are $80 million, what loss is borne by the mezzanine tranche, and what percentage of its principal does this represent?

The mezzanine tranche loses $30 million, or 30% of its principal. The $50 million equity tranche absorbs the first losses, leaving $30 million of the $80 million total loss to hit the $100 million mezzanine tranche, while the senior tranche is untouched.

  1. A$30 million, or 30% of mezzanine principalCorrect
  2. B$80 million, or 80% of mezzanine principal
  3. C$16 million, or 16% of mezzanine principal
  4. D$50 million, or 50% of mezzanine principal

Explanation

Equity absorbs the first $50 million. The remaining $30 million falls on the mezzanine tranche, which has $100 million principal, so 30%. Choosing $80 million ignores the equity buffer, and 16% divides total loss by the pool ($80m/$500m).

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