Consider a CDO made up of six corporate bonds with par value of $100. Assume that...

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Consider a CDO made up of six corporate bonds with par value of $100. Assume that the bonds offer no recovery value in default and that all credit events are independent. Call the first to default tranche of the CDO L₁, the second L2, etc. L₁ bears the first $100 of losses, L₂ the next $100, etc. For a security to be considered AA, the probability of total loss must be less than 5%. How high can the bond's probability of default be for only the most junior tranche to be less than AA rated? 9. What recovery rate that would also make the junior tranche AA using the default prob- ability from the above question? Consider a CDO made up of six corporate bonds with par value of $100. Assume that the bonds offer no recovery value in default and that all credit events are independent. Call the first to default tranche of the CDO L₁, the second L2, etc. L₁ bears the first $100 of losses, L₂ the next $100, etc. For a security to be considered AA, the probability of total loss must be less than 5%. How high can the bond's probability of default be for only the most junior tranche to be less than AA rated? 9. What recovery rate that would also make the junior tranche AA using the default prob- ability from the above question?

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