A CDO has three tranches,a senior tranche,mezzanine tranche,and equity tranche.Keeping the probabilities of default in the CDO collateral fixed,the value of the equity tranche increases if
A)The correlation of default across all names in the CDO increases.
B)The correlation of default across all names in the CDO decreases.
C)The credit quality of names in the CDO collateral declines.
D)The volatility of credit spreads on names in the CDO collateral increases.

Question

Quizplus · Accepted Answer

The equity tranche bears first losses,and is similar to a FTD basket.When default correlation increases,either several names default or none do.This makes the relative value of the equity tranche versus other tranches higher,keeping the value of the collateral fixed.

A CDO Has Three Tranches,a Senior Tranche,mezzanine Tranche,and Equity Tranche