Answer: Both I and II.

## Explanation Both statements correctly describe aspects of the risk mitigation process in a CDO: **Statement I** is correct because CDOs restructure default risk through tranching. Lower-rated debt instruments are pooled together and then divided into different tranches with varying risk levels. The senior tranches receive higher credit ratings because they have priority in cash flow distributions and are protected by the subordinated tranches, effectively transforming lower-rated assets into highly rated securities. **Statement II** is correct because the equity tranche (also called the first-loss piece) bears the highest level of default risk. It absorbs the first losses from the underlying portfolio and has no guaranteed return. The equity tranche investors receive residual cash flows after all other tranches have been paid, making their returns uncertain and highly dependent on the performance of the underlying assets. Therefore, both statements accurately describe the risk mitigation process in CDOs, making option C the correct answer.

Author: LeetQuiz .