9. Consider a collateralized debt obligation (CDO) that has a $250 million structure. The collateral consists of bonds that mature in seven years, and the coupon rate for these bonds is the seven-year Treasury rate plus 500 bps. The senior tranche comprises 70 percent of the structure and has a floating coupon of LIBOR plus 50 bps. There is only one junior tranche that comprises 20 percent of the structure and has a fixed coupon of seven-year Treasury rate plus 300 bps. Compute the rate of return earned by the equity tranche in this CDO if the seven-year Treasury rate is 6 percent and the London Interbank Offered Rate (LIBOR) is 7.5 percent. There are no defaults in the underlying collateral pool.

Ignore the collateral manager’s fees and any other expenses.