CFA Level I · CFA Level I Exam · Mortgage-Backed Security (MBS) Instrument and Market Features
A non-agency RMBS has a senior tranche of 80%, a mezzanine tranche of 12% and an equity (first-loss) tranche of 8% of the pool balance. Ignoring any other enhancement, the senior tranche's credit enhancement from subordination is closest to:
The senior tranche has about 20% subordination. Losses must first exhaust the 8% equity tranche and then the 12% mezzanine tranche before the senior tranche is affected. Counting only one junior tranche would understate the protection.
- A8%
- B12%
- C20%Correct
Explanation
Credit enhancement for the senior tranche equals the share of the pool ranking below it: 12% + 8% = 20%. Using only 8% omits the mezzanine tranche, and 12% omits the first-loss tranche.
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