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CMA Final · Strategic Financial Management · Securitization

A pool of receivables has a principal of Rs 200 crore. The securitisation structure has senior tranche Rs 160 crore, mezzanine tranche Rs 30 crore and an equity (first-loss) piece of Rs 10 crore. If pool losses are Rs 18 crore, which allocation of losses is correct?

Losses hit the most subordinated tranche first. Equity absorbs Rs 10 crore, and the remaining Rs 8 crore falls on the mezzanine tranche, leaving the senior tranche with no loss. A pro rata sharing of losses is wrong in a tranched structure.

  1. AEquity Rs 10 crore, mezzanine Rs 8 crore, senior nilCorrect
  2. BEquity Rs 18 crore, others nil
  3. CSenior Rs 14.4 crore, mezzanine Rs 2.7 crore, equity Rs 0.9 crore
  4. DMezzanine Rs 18 crore, equity nil

Explanation

Losses are absorbed in order of subordination. The equity piece takes the first Rs 10 crore, leaving Rs 8 crore, which the mezzanine tranche absorbs because it has Rs 30 crore. The senior tranche is untouched. Option 3 wrongly shares losses pro rata.

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