Suppose that ABSs are created from portfolios of subprime mortgages with the following allocation of the principal to tranches: senior 85%,mezzanine 10%,and equity 5%.(The portfolios of subprime mortgages have the same default rates.)An ABS CDO is then created from the mezzanine tranches with the same allocation of principal.How high can losses on the mortgages be before the senior tranche of the ABS CDO bears losses?
A) 5.5%
B) 6.0%
C) 6.5%
D) 7.0%

Question

Quizplus · Accepted Answer

If losses are 6.5%,the mezzanine tranches of ABSs lose 1.5/10 or 15% of their principal.The senior tranches of the ABS CDO is then safe (just).

Suppose That ABSs Are Created from Portfolios of Subprime Mortgages