Question: Collateralized Debt Obligation (CDO) Problem (15 points) An investment bank has created a CDO by pooling 100 bonds which will either pay off $0 (in

Collateralized Debt Obligation (CDO) Problem (15 points)

An investment bank has created a CDO by pooling 100 bonds which will either pay off $0 (in case of default) or pay off $1. The CDO has three risk classes rated AAA, BBB, and CCC with face values of $70, $20, and $10, respectively. The current prices of the tranches are respectively, $66, $12, and $1. Consider the strategy of buying one unit (out of 100 units) of the BBB class and shorting one unit of the AAA tranche. How many bonds will have to default for this portfolio to make money?

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