The correct answer is D.

Asset-backed securities are divided into tranches to distribute risk. The equity tranche is the riskiest as it is the first to absorb losses. This tranche is often referred to as the 'first loss' piece as it takes the first hit when there are defaults on the underlying assets. The mezzanine tranche is less risky than the equity tranche but riskier than the senior tranche. It absorbs losses only after the equity tranche has been completely wiped out. The senior tranche is the least risky as it is the last to absorb losses. It is protected by both the equity and mezzanine tranches which absorb losses first. Therefore, from the riskiest to the least risky, the order is: Equity tranche, Mezzanine tranche, Senior tranche.

Things to Remember

• Asset-backed securities (ABS) are financial securities backed by a pool of assets such as loans, leases, or receivables.
• Tranching is the process of creating different classes of securities with different levels of risk and return from the same pool of assets.
• Senior tranches have the highest credit rating and lowest yield, while equity tranches have the lowest credit rating and highest yield.
• Mezzanine tranches are in between senior and equity tranches in terms of risk and return.
• ABS tranches are structured to provide investors with options based on their risk tolerance and return objectives.