medium · FRM Part 2 Credit Risk
An institutional fund manager is comparing two collateralized loan pools with the same expected loss of 5%. Pool A has a default correlation of 0.05, and Pool B has a default correlation of 0.40.
If the manager holds a senior tranche with an attachment point of 15%, which pool is riskier for the senior investor?
- Both pools have the same risk because their expected losses are equal
- Pool A is riskier, since low default correlation makes losses harder to forecast
- Pool B, because high correlation creates fatter tails in the loss distribution
- Pool A carries more risk, as it offers the senior tranche less diversification benefit
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