Explanation:
In a structured solution, all portfolio losses are first absorbed by the equity tranche. Only after the equity tranche has been exhausted are the losses applied to the junior and senior debt tranches, respectively. For a $800 million loss, the equity tranche will absorb $500 million and then the remaining $300 million will be applied to the junior tranche.
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Q.2707 A structured solution worth $2 billion has the following capital structure:
| Equity tranche | $500 million |
|---|---|
| Junior debt | $700 million |
| Senior debt | $800 million |
Which of the following statements correctly describes how an $800 million loss will be absorbed by the different tranches?
A
All of the losses are absorbed by the senior tranche.
B
$700 million is absorbed by the junior tranche and $100 million is absorbed by the equity tranche.
C
$500 million is absorbed by the equity tranche and $300 million is absorbed by the senior tranche.
D
$500 million is absorbed by the equity tranche and $300 million is absorbed by the junior tranche.
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