CFA Level I · CFA Level I Exam · Asset-Backed Security (ABS) Instrument and Market Features
In a CDO, the tranche that is most likely to receive the highest expected return, and absorb losses first, is the:
The equity tranche absorbs losses first and is paid last, taking the residual cash flows. Because it bears the most credit risk, it has the highest potential return. Senior tranches are protected by subordination and offer lower yields, with mezzanine tranches falling in between.
- Asenior tranche
- Bequity trancheCorrect
- Cmezzanine tranche
Explanation
Losses on the collateral pool are allocated first to the equity tranche, the most subordinated, so it carries the greatest risk and receives the residual cash flows with the highest potential return. Senior tranches are paid first and are last to bear losses, so they offer the lowest yield.
Did you get it right without looking?
One question tells you little. A timed set on Asset-Backed Security (ABS) Instrument and Market Features shows your real accuracy, how long you take and where you lose marks.
More Asset-Backed Security (ABS) Instrument and Market Features questions
- An auto loan asset-backed security is backed by a pool of loans that borrowers can repay early. Which feature of the cash flows is most like…
- Compared with internal credit enhancement, external credit enhancement in an ABS structure, such as a bond insurance guarantee from a third …
- A bank sells a pool of auto loans to a special purpose entity, which issues ABS. The bank then enters insolvency. Which outcome is most like…
- A court finds that an originator kept control over the receivables it transferred to its special purpose entity and treated the entity as a …
- In a securitization, the servicer is most likely responsible for:
- In a sequential-pay ABS structure, a securitization has a senior tranche, a mezzanine tranche and a subordinated tranche. Credit losses on t…