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FRM Part I · FRM Exam Part I · Banks

A securitization pool has a principal of USD 500 million. The tranches are: senior USD 400 million, mezzanine USD 70 million, equity USD 30 million. Losses on the pool total USD 50 million. What is the loss borne by the mezzanine tranche, and what percentage of its principal does this represent?

The mezzanine tranche loses USD 20 million, or 28.6% of its principal. The equity tranche absorbs the first USD 30 million of the USD 50 million pool loss, leaving USD 20 million for the USD 70 million mezzanine tranche, and the senior tranche suffers nothing.

  1. AUSD 20 million, 28.6%Correct
  2. BUSD 50 million, 71.4%
  3. CUSD 16.7 million, 23.8%
  4. DUSD 10 million, 14.3%

Explanation

The equity tranche absorbs the first USD 30 million. The remaining USD 20 million falls on the mezzanine tranche, which is below its USD 70 million principal, so the senior tranche is untouched. Loss rate is 20/70 = 28.6%. The 14.3% option wrongly assumes USD 10 million.

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