Hi, I was hoping someone could help me on the above. I have understood how a CDO is structured. With reference to April 2011Q8, can someone please explain me the concept of attachment points (in terms of losses) and also how the returns for each tranche are defined? Thanks
Hi Darshan (Worth also referring also to the post on April 2017 - CDOs). Attachment points determine the level of subordination that tranches have relative to each other – and hence how the risks and losses flow through the various tranches. For example, suppose the tranche structure is 40% Senior, 40% Mezzanine and 20% Equity. These percentages represent the expected split of the payments to the different tranches (or in other words the liabilities of the SPV). To try and relate to the April 2017 - CDOs post, for example, the SPV may be expecting income from the mortgages to the SPV to be £25m and hence liabilities split as payouts of £10m per year to the senior tranche, £10m per year to the mezzanine tranche and £5m a year to the equity tranche. Then the operation might be as follows: the Equity tranche has no subordination – ie there is no debt that ranks lower than the Equity tranche the Mezzanine debt tranche has 20% subordination and the attachment point is at the 20% loss level – ie 20% of the debt ranks below the mezzanine tranche and the Mezzanine tranche would be expected to incur default losses if the income from the mortgages is more than 20% lower than expected the Senior debt tranche has 60% subordination and attaches at the 60% loss level – ie 60% of the debt ranks below the senior tranche and the Senior tranche would be expected to incur default losses if the income from the mortgages is more than 60% lower than expected. By varying the attachment points, the exposure of the Mezzanine / Senior tranches to losses can be changed – this in turn affects the credit ratings of the various tranches and hence the expected returns and prices. Does this help at all? Anna
