medium · FRM Part 2 Credit Risk
How does an 'Overcollateralization (OC) Test' in a Collateralized Loan Obligation (CLO) protect senior noteholders during a credit downturn?
- It forces immediate liquidation of all underlying loan collateral to repay senior notes at full par value.
- It raises the coupon rate owed to senior noteholders as compensation for the elevated portfolio credit risk.
- It redirects interest cash flows to pay down senior principal if the collateral-to-notes ratio falls below a threshold.
- It obligates the collateral manager to inject fresh capital contributions directly into the special-purpose vehicle.
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