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FRM Part II · FRM Exam Part II · Structured Credit Risk

A CLO issues three tranches against a $500 million loan pool: a senior tranche of $350 million, a mezzanine tranche of $100 million and an equity tranche of $50 million. Pool losses are first absorbed by the equity tranche, then mezzanine, then senior. What is the subordination (credit enhancement from tranches below) available to the mezzanine tranche, as a percentage of the pool?

The mezzanine tranche has 10% subordination. Only the $50 million equity tranche ranks below it and absorbs losses first, and $50 million divided by the $500 million pool equals 10%. The 30% figure applies to the senior tranche, which has both mezzanine and equity beneath it.

  1. A10%Correct
  2. B20%
  3. C30%
  4. D70%

Explanation

Subordination for a tranche is the amount of capital ranking below it. Only the equity tranche of $50 million sits below the mezzanine, so subordination is 50/500 = 10%. The 30% figure is the senior tranche's subordination (mezzanine plus equity, 150/500 = 30%), and 20% is the mezzanine tranche's own thickness (100/500).

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