FRM Part II · FRM Exam Part II · Credit Derivatives
A synthetic CDO references a portfolio with a total notional of USD 1,000 million. A mezzanine tranche has an attachment point of 4% and a detachment point of 10%. After a credit event sequence, cumulative portfolio losses are USD 75 million with no recoveries beyond those already netted in the loss figure. What is the loss borne by the mezzanine tranche as a percentage of its tranche notional?
The mezzanine tranche loses 58.3% of its notional. Its size is USD 60 million, losses begin after USD 40 million, and USD 75 million of portfolio losses leave USD 35 million allocated to the tranche, which is 35 divided by 60.
- A25.0%
- B58.3%
- C41.7%Correct
- D75.0%
Explanation
Tranche size = (10% - 4%) x 1,000 = USD 60 million. Portfolio loss of 75 exceeds the 40 attachment, so tranche loss = 75 - 40 = 35 million. Tranche loss percentage = 35/60 = 58.3%. Wait: this gives 58.3%, so check options: 35/60 = 58.3%, which is option 1.
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