medium · FRM Part 2 Credit Risk
An analyst is comparing two portfolios with the same expected loss but different default correlations. Portfolio A has low correlation, and Portfolio B has high correlation.
Which of the following is true regarding the risk of the senior tranches in a securitization of these portfolios?
- The senior tranche of Portfolio B is riskier because high correlation increases the probability of extreme tail events that can breach senior subordination.
- The senior tranche of Portfolio A is riskier because idiosyncratic defaults occur more frequently, steadily eroding the equity layer faster.
- The equity tranche of Portfolio B is safer because high correlation decreases the likelihood of any defaults occurring at all in most scenarios considered.
- Both senior tranches have identical risk because the expected loss (EL) of the two underlying pools is the same, regardless of the correlation structure assumed.
Sign up free to see the explanation and track your rank →
More FRM Part 2 Credit Risk practice
- According to the structural Merton model, the equity of a levered firm can be viewed as wh
- What is the primary reason why risk-neutral probabilities of default (PD) extracted from c
- A bank utilizes a 'through-the-cycle' (TTC) rating system. During a sharp economic downtur
- If the Area Under the Curve (AUC) from the Receiver Operating Characteristic (ROC) is 0.85
- A Merton-style structural credit model treats a firm's equit… — In this framework, what do
- For a derivatives portfolio, which Counterparty Credit Risk (CCR) metric is primarily used
- In the comparison of rating system philosophies, which system is characterized by stable r
- A bank's internal model for Credit Value Adjustment (CVA) us… — Why is this required by re