Suppose that ABSs are created from portfolios of subprime mortgages with the following allocation of the principal to tranches: senior 80%, mezzanine 10%, and equity 10%
(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. Losses on the mortgage portfolio prove to be 16%. What, as a percent of tranche principal, are losses on the senior tranche of the ABS CDO
A. 50%
B. 60%
C. 80%
D. 100%
A
As the answer to the previous question shows the senior tranche of the ABS CDO absorbs 40% losses. It is therefore 40%/80% or 50% wiped out.
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