FRM Part II · FRM Exam Part II · Credit Risk
A synthetic CDO has a pool of USD 1,000 million of reference exposures. Tranches are: equity 0-3%, mezzanine 3-10%, senior 10-100%. Cumulative pool losses reach USD 65 million at maturity. What are the losses allocated to the mezzanine tranche and the senior tranche respectively?
Mezzanine loses USD 35 million and senior loses nothing. Equity absorbs the first USD 30 million, being 3 percent of the pool. The next USD 35 million falls in the mezzanine band, which runs to USD 100 million, so losses never reach the senior attachment point.
- AUSD 35 million and USD 0Correct
- BUSD 30 million and USD 35 million
- CUSD 35 million and USD 30 million
- DUSD 65 million and USD 0
Explanation
Equity absorbs the first 3% = USD 30 million. Mezzanine covers 3-10%, i.e. USD 30-100 million, so it absorbs the remaining 65 - 30 = USD 35 million, which is within its USD 70 million width. Senior attaches at USD 100 million, so its loss is zero. Check: 30 + 35 + 0 = 65.
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