Financial Risk Manager Part 2
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A financial firm has sold default protection on the most senior tranche of a CDO. If the default correlation between assets held in the CDO decreases sharply from the correlation used in pricing the CDO tranches, assuming everything else is unchanged, how will the position of the financial firm be impacted?
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.