Question

Which statements are true about an ABS CDO created from the mezzanine tranche of an ABS? Check all that apply:

a) ABS CDOs are created to create more AAA-rates tranches.
b) The senior tranche of the ABC CDO is less risky than the senior tranche of the ABS.
c) If the underlying assets lose 10% of their value, investors in the ABS CDO mezzanine tranche can lose at most 10% of their investment.
d) Investors in the ABS CDO equity tranche are promised higher returns than investors who buy into the ABS CDO mezzanine tranche.

Answer 1

True statements about an ABS CDO created from the mezzanine tranche of an ABS are that they create more AAA-rated tranches and that equity tranche investors are promised higher returns due to higher risks. The statement about the mezzanine tranche losing only a maximum of 10% if assets depreciate by that amount is false.

Step-by-step explanation:

To understand which statements are true about an ABS CDO created from the mezzanine tranche of an ABS, let's consider the options provided:

• a) True: ABS CDOs are often created to engineer higher-rated tranches from portfolios of lesser-rated securities, thus creating more AAA-rated tranches.
• b) May be true: The senior tranche of the ABS CDO could be considered less risky if the structuring of tranches effectively disburses underlying risks. However, risk comparisons depend on specific deal structures and asset performance.
• c) False: If the underlying assets lose 10% of their value, investors in the ABS CDO mezzanine tranche can potentially lose more than 10% depending on the tranche's subordination level and the performance of underlying assets.
• d) True: Investors in the ABS CDO equity tranche are typically promised higher returns to compensate for the higher risk of loss.

Thus, statements a) and d) are correct, whereas b) might be correct based on context, but c) is a misconception likely stemming from a misunderstanding of the structure of CDO tranches and their risk profiles.