CFA Level I · CFA Level I Exam · Fixed-Income Securitization
In a CMBS structure, an investor holds a tranche with a high credit rating. The credit enhancement that most likely protects this tranche from losses on the loan pool is:
Subordination of lower-rated tranches most likely protects a highly rated CMBS tranche, because junior tranches absorb credit losses first. Prepayment penalties and a shorter weighted average life do not shield senior holders from defaults in the loan pool.
- Asubordination of lower-rated tranches that absorb losses firstCorrect
- Ba higher prepayment penalty on the senior notes
- Ca shorter weighted average life on the pool
Explanation
CMBS use a senior-subordinated structure in which the lower-rated tranches absorb losses before the senior tranche. Prepayment penalties and shorter life affect prepayment or maturity, not loss absorption.
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