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CFA Level I · CFA Level I Exam · Fixed-Income Securitization

A securitization has a collateral pool of 100 million. The structure includes 10 million of subordination, where the pool loses 6 million to defaults and no excess spread is available. Investors in the senior tranche are most likely to:

Senior investors most likely suffer no loss. The 10 million subordinated tranche absorbs losses first, and the 6 million of defaults is smaller than that cushion, leaving 4 million of protection still in place. The senior tranche is affected only if losses exceed 10 million.

  1. Aabsorb 6 million of the loss first
  2. Babsorb a 4 million loss after the subordinated tranche is exhausted
  3. Csuffer no loss because subordinated tranches absorb the 6 millionCorrect

Explanation

Losses are allocated first to the subordinated tranche, which has 10 million of capacity. The 6 million loss is below 10 million, so it is fully absorbed there, leaving 4 million of subordination remaining and the senior tranche untouched. Absorbing a loss only after exhaustion would require losses above 10 million.

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