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CA Final · Advanced Financial Management · Securitization

In a securitization, the investors' securities are structured into senior and subordinated tranches so that the first losses on the pool are borne by the subordinated tranche. Which feature of the structure does this describe?

This describes credit enhancement through subordination. The junior tranche absorbs first losses, which protects the senior tranche and supports a higher rating for it. It differs from a pass-through arrangement, bankruptcy remoteness, or a servicing arrangement.

  1. APass-through arrangement
  2. BCredit enhancement through subordinationCorrect
  3. CBankruptcy remoteness of the originator
  4. DServicing arrangement

Explanation

When a junior tranche absorbs losses before the senior tranche, the senior investors are protected, which improves their rating. This is subordination, an internal credit enhancement. A pass-through merely transfers collections to investors, and bankruptcy remoteness concerns isolating the SPV's assets from the originator.

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