Series 7 practice questionhardCDOs — Tranche Risk
In a CDO structure, which tranche bears the first losses from defaults in the underlying collateral pool?
- ASenior tranche
- BMezzanine tranche
- CEquity tranche (first-loss piece)✓ Correct answer
- DAll tranches share losses equally
Explanation
Why C — Equity tranche (first-loss piece)
The equity tranche (also called the first-loss piece or residual tranche) absorbs the first losses from defaults in the underlying collateral pool. Losses are allocated from the bottom up: equity tranche first, then mezzanine, and finally senior tranche. In exchange for bearing the highest risk, the equity tranche receives the highest potential yield. The senior tranche has the most protection and typically receives the highest credit rating, often AAA.
Turn it into reps
Reading one answer is not the same as being ready
Lucky the Banker is a free practice app with 758+ Series 7 questions, weak-area tracking, and timed mock exams. No credit card, no paywall.
Spot an error in this question or explanation? Tell us — we fix these fast.
Related Investment Information & Recommendations questions
- A credit card asset-backed security enters its 'amortization period.' This means:
- The weighted average life (WAL) of a mortgage-backed security is affected MOST by:
- An investor seeking the SAFEST short-term investment with maximum liquidity should consider:
- An institutional investor purchases a $1 million negotiable CD with a 6-month maturity. After 3 months, the investor…
- A call option gives the holder the right to do which of the following?
- In a rising interest rate environment, which CMO tranche would be MOST negatively affected?
- A put option gives the holder the right to do which of the following?
- In the securitization process, the entity that creates the asset-backed securities by purchasing the underlying assets…