Consider three bonds X, Y , and Z, each of which pays $1000 if it does not default, and nothing in case of default. The default probabilities are 0.3, 0.2, and 0.1 respectively,and the default correlations are all zero. These bonds are bundled together to form an asset pool, and a prioritized structure of claims (tranches) against this pool are issued. There are three tranches (senior, mezzanine, and junior), each of which promise $1000. If there are insucient funds to make all promised payments, then all losses are applied rst to the junior tranche, then to the mezzanine, and nally to the senior tranche.

(a) Write down the list of all possible outcomes and identify which of these outcomes would cause the mezzanine tranche to default.

(b) What is the default probabilty of the mezzanine tranche?

(c) What is the expected value of payment for the mezzanine tranche?

Answer rating: 100% (QA)

To determine the possible outcomes and identify the scenarios that would cause the mezzanine tranche ... View the full answer