CAS Exam 9 Spring 2019, Question 10
Study guide: Exam 9
An asset manager wants to construct a Collateralized Debt Obligation Squared (CDO²) composed of the junior tranches of two Collateralized Debt Obligations (CDOs).
Given the following:
- The CDOs are composed of two 2-year securities, which pay $500 at maturity and $0 at default
- One CDO is composed of securities with 10% default probability and the other CDO is composed of securities with 30% default probability
- All securities are uncorrelated
- Each CDO and CDO² has a junior tranche with attachment points 0% - 50% of the notional principal and a senior tranche with attachment points 50% - 100% of the notional principal
- The discount rate and risk-free rate are both 5%
Part a (1 point)
Calculate the price of the senior tranche of the CDO².
Part b (0.5 points)
Calculate the default premium of the senior tranche of the CDO².
Part c (0.5 points)
Upon further review, the asset manager determines that the correct default probabilities should be 10 percentage points higher for each security. Discuss whether the CDO junior tranche or CDO² senior tranche is more sensitive to this change.
Answer this question and see the worked solution