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CFA Level I · CFA Level I Exam · Asset-Backed Security (ABS) Instrument and Market Features

Compared with a pass-through structure with a single class of investors, creating senior and subordinated tranches in a securitization most likely:

Creating senior and subordinated tranches provides internal credit enhancement, because the junior tranches absorb losses first. This raises the credit quality of the senior tranche. Servicers and trustees are still required, and losses are allocated by priority rather than shared equally.

  1. Aincreases the credit quality of the senior tranche through credit enhancement from the subordinated tranchesCorrect
  2. Bremoves the need for any servicer or trustee
  3. Cgives all tranche holders an equal claim on pool losses

Explanation

Subordination is internal credit enhancement: junior tranches absorb losses first, which raises the credit quality of the senior tranche. Servicers and trustees are still needed, and losses are not shared equally across tranches.

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