Financial Risk Manager Part 2
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A financial institution has provided default coverage for the highest tranche of a Collateralized Debt Obligation (CDO). Consider a scenario where the correlation of defaults among the assets within the CDO significantly decreases from the original correlation level used when pricing the CDO tranches, while all other variables remain unchanged. How will this change impact the financial firm's position?
A
It will either increase or decrease, depending on the pricing model used and the market conditions.
B
It will gain significant value, since the probability of exercising the protection falls.
C
It will lose significant value, since the protection will gain value.
D
It will neither gain nor lose value, since only expected default losses matter and correlation does not affect expected default losses.