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Answer: Senior tranches are assigned the highest ratings, while equity tranches yield the highest returns.
## Explanation In Asset-Backed Securities (ABS) structures: **Senior Tranche:** - Receives cash flows first from the underlying assets - Least exposed to default risk - Typically assigned the highest credit rating (often AAA) - Offers lower returns due to lower risk **Equity Tranche:** - Receives cash flows last - Bears the first losses if underlying assets default - Most risky tranche - Often unrated - Offers the highest expected returns to compensate for higher risk **Mezzanine Tranche:** - Falls between senior and equity tranches - Moderate risk and return profile **Why Choice C is correct:** - Senior tranches get highest ratings due to lower risk - Equity tranches yield highest returns due to higher risk - This reflects the fundamental risk-return trade-off in finance **Why other choices are incorrect:** - **A:** Senior tranches have high ratings but NOT highest returns - **B:** Equity tranches have highest returns but NOT highest ratings - **D:** Equity tranches cannot have both highest ratings and returns; mezzanine doesn't yield highest returns
Author: Tanishq Prabhu
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In the structure of Asset-Backed Securities (ABSs), the senior tranche is typically assigned the highest rating, while the equity tranche is expected to yield the highest returns. This is due to the risk-return trade-off inherent in these securities.
A
Senior tranches are assigned the highest ratings and yield the highest returns.
B
Equity tranches receive the highest ratings and provide high expected returns.
C
Senior tranches are assigned the highest ratings, while equity tranches yield the highest returns.
D
Equity tranches receive the highest ratings and provide high expected returns, while mezzanine tranches yield the highest return.
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