Large Bank Examination Workshop February 2026

Exercise: CDO Tranche Risk 1. Consider a CDO based on a pool of 100 mortgage loans, all with the same notional value. a) If you invest in a 3-6% mezzanine tranche of this CDO and the recovery rate on the loans in the event of default is 0%, how many defaults that can occur before you suffer any loss?

b) If there are five defaults, what fraction of your tranche is lost?

c) After how many defaults will your tranche be completely lost?

145

Exercise: CDO Tranche Risk

2. Suppose now that the recovery given default on the loans is 50% rather than 0%.

a) How many defaults can occur before your 3-6% mezzanine tranche suffers any losses?

b) After how many defaults will your tranche be completely lost?

3. Would a 9-16% senior tranche be more risky or less risky than a 9-12% senior tranche, assuming that both were based on the same collateral pool? Why?

4. Which of the two tranches should pay a higher coupon?

146

73

© Global Financial Markets Institute Inc.