Which description BEST characterizes a single-tranche CDO?
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Correct Answer: D
Solution
D is correct. In a single-tranche CDO, the sponsor sells only one tranche to an outside investor and may retain the other tranches on its balance sheet. Like a synthetic CDO, it uses CDS, but it transfers only a specific slice of the portfolio's risk. Terms such as collateral composition, maturity and average rating can be tailored, so these structures are called bespoke CDOs, or CDOs on demand.
Question 2
Medium
A CMBS structure uses tranching primarily to:
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Correct Answer: B
Solution
B is correct.
Tranching in a CMBS structure redistributes the credit risk of the underlying mortgage pool among different classes (tranches) of bondholders. Senior tranches have first claim on cash flows and are protected by subordination from junior tranches, which absorb losses first. This allows different investors to select risk-return profiles that match their preferences.
Question 3
Hard
Which combination of distributional features best summarizes the historical pattern of mortgage REIT returns?
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Correct Answer: A
Solution
A is correct. Historical mortgage REIT returns have displayed negative skewness, reflecting a more pronounced tail toward large losses. Their positive excess kurtosis also indicates that extreme outcomes are more prominent than a normal distribution would suggest.
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