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FRM Part I · FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009

A mortgage-backed securities structure has a $1,000 million pool. The tranches are: senior $800 million, mezzanine $150 million, equity $50 million. Losses are absorbed from the bottom up. If the pool suffers a loss of 12% of its principal, what is the loss to the mezzanine tranche as a percentage of its own principal?

The mezzanine tranche loses 46.7% of its principal. A 12% loss on a $1,000 million pool is $120 million; the equity tranche absorbs the first $50 million and the remaining $70 million falls on the $150 million mezzanine tranche.

  1. A20.0%
  2. B46.7%
  3. C70.0%Correct
  4. D100.0%

Explanation

Pool loss = 12% x 1,000 = $120 million. Equity absorbs the first $50 million, leaving $70 million for the mezzanine. Mezzanine loss = 70/150 = 46.7%. Correction: the mezzanine loss is 46.7%, not 70%; 70% would wrongly divide by 100.

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