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

Under the Basel securitisation framework's SEC-IRBA/SSFA-type formulas, a tranche's capital charge depends on pool capital K, attachment point A and detachment point D. A tranche has A = 6% and D = 12%, and the pool's capital requirement K is 8%. Which statement is correct about the tranche's treatment?

Because the tranche straddles K, the slice from 6% to 8% below K receives a 1,250% risk weight, while only the slice from 8% to 12% above K gets the lower formula-based weight. The tranche is neither fully deducted nor entirely above K.

  1. AThe whole tranche is deducted, since it is a first-loss piece
  2. BThe tranche is entirely above K, so it receives only the floor risk weight
  3. CThe portion from 6% to 8% is treated with a 1,250% risk weight, and only the portion from 8% to 12% benefits from lower risk weightsCorrect
  4. DThe tranche receives the pool's average risk weight because it is mezzanine

Explanation

When a tranche straddles K, the part below K (A to K, here 6% to 8%) is risk weighted at 1,250% as it absorbs losses expected to be covered by pool capital. The part above K (8% to 12%) receives the formula-based lower weight. The tranche is neither wholly deducted nor wholly above K.

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