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CFA Level I · CFA Level I Exam · Mortgage-Backed Security (MBS) Instrument and Market Features

In a non-agency residential mortgage-backed security, the creation of a senior tranche and a subordinated tranche, with losses absorbed first by the subordinated tranche, is best described as:

Subordination is internal credit enhancement. It is built into the deal structure by tranching, so junior tranches absorb losses before senior tranches. External enhancement relies on third parties such as insurers or guarantors, and non-agency RMBS carry no government guarantee.

  1. Aexternal credit enhancement
  2. Binternal credit enhancementCorrect
  3. Ca government guarantee

Explanation

Subordination is a form of internal credit enhancement because it is built into the securitization structure through the tranching of cash flows. External enhancement comes from a third party such as a monoline insurer or a guarantee. Non-agency RMBS have no government guarantee.

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