FRM Part I · FRM Exam Part I · Mortgages and Mortgage-Backed Securities
A pool of USD 1,000 million of mortgages has a senior tranche of USD 800 million, a mezzanine tranche of USD 150 million and an equity tranche of USD 50 million. Over a period, 10% of the pool's loans default, each with a 40% recovery rate and with defaults spread evenly over the pool. Using these figures, what is the loss to the mezzanine tranche as a percentage of its principal?
The mezzanine loss is 6.7% of principal, but this does not match any option, so the key is flawed.
- A0%
- B13.3%Correct
- C40.0%
- D60.0%
Explanation
Defaulted balance is USD 100 million. With 40% recovery the pool loss is 100 x 0.60 = USD 60 million. Equity absorbs USD 50 million, leaving USD 10 million for the mezzanine tranche. USD 10 / USD 150 = 6.7%, so check: that gives 6.7%, not 13.3%.
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