Skip to content

FRM Part I · FRM Exam Part I · Credit Risk Transfer Mechanisms

A securitization has a $500 million asset pool financed by an equity tranche of $25 million (first loss), a mezzanine tranche of $75 million, and a senior tranche of $400 million. Pool losses are $60 million. Assuming losses are allocated sequentially from the bottom up, what is the loss absorbed by the mezzanine tranche, and what percentage of that tranche's principal does this represent?

The mezzanine tranche loses $35 million, or 46.7% of its $75 million principal. The equity tranche absorbs the first $25 million of the $60 million pool loss, leaving $35 million for the mezzanine tranche, and the senior tranche is unaffected.

  1. A$35 million, 46.7%Correct
  2. B$60 million, 80.0%
  3. C$25 million, 33.3%
  4. D$10 million, 13.3%

Explanation

Equity absorbs the first $25 million. The remaining $35 million goes to mezzanine, which is 35/75 = 46.7% of its principal. The senior tranche is untouched because mezzanine is not exhausted. $60 million ignores the equity buffer; $25 million is the equity loss, not the mezzanine loss.

Did you get it right without looking?

One question tells you little. A timed set on Credit Risk Transfer Mechanisms shows your real accuracy, how long you take and where you lose marks.

Practise Credit Risk Transfer MechanismsFree diagnostic mock

More Credit Risk Transfer Mechanisms questions