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FRM Part II · FRM Exam Part II · An Introduction to Securitisation

Under the Basel framework, which securitisation exposure is typically assigned the highest risk weight, reflecting its position in the loss-absorption waterfall?

The first-loss or equity tranche receives the highest treatment, a 1,250% risk weight or capital deduction, because it absorbs the first losses in the pool. Senior, super-senior and rated mezzanine tranches carry lower risk weights based on seniority and credit enhancement.

  1. AA senior tranche with high credit enhancement
  2. BA mezzanine tranche rated A
  3. CA first-loss (equity) tranche, which is usually deducted from capital or given a 1,250% risk weightCorrect
  4. DA super-senior tranche backed by prime mortgages

Explanation

The first-loss tranche absorbs the initial losses and is the most exposed, so Basel assigns it a 1,250% risk weight, equivalent to a full capital deduction. Senior and mezzanine tranches have lower risk weights that depend on attachment point, thickness and ratings.

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