CFA Level I · CFA Level I Exam · Fixed-Income Securitization
A securitization has a senior tranche, a mezzanine tranche and a subordinated tranche. Losses on the collateral are allocated first to the subordinated tranche. This credit enhancement is best described as:
This is subordination, also called credit tranching. Losses are absorbed first by the junior tranche, protecting senior and mezzanine tranches. Overcollateralization instead relies on excess collateral, and a reserve account relies on cash held aside.
- Aovercollateralization
- Ba reserve account
- CsubordinationCorrect
Explanation
Subordination, or credit tranching, directs losses first to the junior tranches and protects the senior tranches. Overcollateralization means collateral value exceeds the issued bond principal. A reserve account is a cash set-aside.
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