What's new

P2.T6.315. Tranche sensitivities in structure products

Pam Gordon

New Member
AIMs: Define and describe how default sensitivities for tranches are measured. Summarize some of the different types of risks that play a role in structured products. Identify the motivations for using structured credit products.


315.1. According to Malz, "The default01 measures the impact of an increase of one (1) basis point in the default probability. It is analogous to the DV01 and the spread01 and is calculated numerically in a similar way. To compute the default01, we increase and decrease default probability 10bps and revalue each tranche at these new [default probability] values ... Each default01 is expressed as
a positive number and expresses the decline in value or increase in loss resulting from a 1-basis point rise in default probability." (Source: Allan Malz, Financial Risk Management: Models, History, and Institutions (Hoboken, NJ: John Wiley & Sons, 2011))

Each of the following is true about default01 EXCEPT which is false?

a. For all tranches, in all cases, default01 is positive regardless of the initial value of default probability correlation, since equity and bond values decrease monotonically as the default probability rises
b. Because default01 "models correlation as constant according to an implicit ceteris paribus," default01 is invariant (insensitive) to different correlation levels
c. The default01 sensitivity converges to zero for all the tranches for very high default rates
d. the peak default01 is at a default probability of zero for the equity tranche (its attachment point), and occurs at a lower default rate for the mezzanine than for the senior tranche because it has a lower attachment point

315.2. In the three-tiered (senior bond, mezzanine and equity tranche) securitization structure, Malz tends to measure the risk of a tranche by its 95% and/or 99% Credit VaR. In regard to tranche risks, each of the following is true EXCEPT which is false?

a. Credit VaR is the worst case loss at the 0.05 or 0.01 quantile minus the expected loss (EL)
b. High systemic risk can be expressed as high default correlation, when tends to increase the risk (Credit VaR) of senior bonds
c. An increase in tranche thickness (width) tends to correspond with an increase in the difference between the 95 and 99% Credit VaR
d. An increase in granularity can significantly diminish securitization risk

315.3. In regard to the motivations of issuers or investors in a securitization, according to Malz, each of the following is true EXCEPT which is not?

a. Securitizations undertaken primarily to capture the spread between the underlying loan interest and the coupon rates of the liabilities are sometimes called arbitrage CDOs, while securitizations motivated largely for balance sheet relief are termed balance-sheet CDOs
b. An important motive of the issuer for securitization is that it provides a technology for maturity matching; i.e., for providing term funding for the underlying loans
c. Tranching technology is primarily motivated by issuers, investors do not require it
d. Mezzanine tranches have less of a natural investor base than other securitized credit products because they may may behave like a senior tranche (i.e., low probability of loss but high systematic risk) or they may behave more like an equity tranche (i.e., high probability of impairment)



New Member
I think the answer to 315.1 is B, because statements a, c, and d was mentioned in the text book.
I also have a question regarding the default01.
The textbook points out that default01 is always positive, but the formula for default01 is:

1/20[(mean value/loss based on PD+0.1%)-(mean value/loss based on PD-0.1%)]
I understand the loss based on high PD should exceed that base on a lower PD, so the denominator is large, and similarly the numerator is lower than mean value based on the low PD, so the first fraction should be smaller than the latter fraction, why should the value of default01 be positive?
@David Harper


New Member
Views required on New Framework for capital Computation for Securitization Risk in Banking Book
BIS (read BASEL) has recently come up with new guidelines on computing capital requirement for securitization risk for Banks.
I am particularly exploring the concept of External rating based approach. Here there seem to be two points of discussion on which I require inputs:

1) Attachment point (AP) and detachment point (DP) which is an input in the RWA output.
The Basel definition in the document is little ambiguous. My opinion is that both these points would be between 0 and 100 (%) and the criteria would be to segregate tranches based on tranche width which would decide both the points AP & DP. Is this approach correct?

2) what is the total exposure to be taken for computing capital for each tranche?
Basel recommends a 1250% RW for banks which don't use any approach and hence this would mean that we keep capital equal to exposure. Based on this my question arises whether while computing the capital requirement total exposure to securitisation should be used or only the tranche exposure? if we take individual tranche exposure than the capital requirement is coming way below the 1250% RW capital requirement(i.e. no method is used direct multiplication with exposure)

Views of the readers are utmost welcome.