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FRM Part II · FRM Exam Part II · An Introduction to Securitisation

A securitisation has a pool of USD 1,000 million with an equity tranche of 0%-5%, a mezzanine tranche of 5%-15% and a senior tranche of 15%-100%. Pool losses in a stress scenario reach 12% (USD 120 million). Ignoring recoveries beyond those losses and any excess spread, what is the loss on the mezzanine tranche as a percentage of its own principal?

The mezzanine tranche loses 70% of its principal. Equity absorbs the first USD 50 million of the USD 120 million pool loss, leaving USD 70 million for the mezzanine tranche, whose principal is USD 100 million (5% to 15% of the pool).

  1. A70%Correct
  2. B12%
  3. C100%
  4. D20%

Explanation

Equity absorbs the first 5% (USD 50 million). Remaining pool loss is 120 - 50 = USD 70 million, which falls in the mezzanine tranche. Mezzanine principal is 10% of 1,000 = USD 100 million, so loss is 70/100 = 70%. The 12% option wrongly applies the pool loss rate directly to the tranche.

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