Actually I thought about it as a basket CDS or a CDO, with 10th to default basket = senior tranche. And same thing for lower tranches,
Let probability of default = 1% for each of 10 baskets. If default correlation = 0, P[>=1 default] = 1-0.99^10 = 0.096. This is the probability of triggering the junior tranche.
If default correlation is exactly 1, P[>=1 default] =0.01. Hence probability of triggering first default decreases making the 1st to default basket or 'CDO junior tranche' expensive.
The opposite can be shown for 10th to default baskets or Senior Tranches.
I.E if default correlation = 0. P[10 defaults] = 0.10 ^10 ~ 0%. If default correlation = 1. P[10 defaults] = 0.01. Thus probability of triggering Senior trance increases with default correlation. Hence the price of 10 th to default basket or Senior tranche decreases. This would have been my answer. Saying value alone perhaps should be explained further e.g examiner report and ASET speak about equity tranche increasing in value but do not explain 'value to who?'
Last edited by a moderator: Mar 16, 2013