ABS CDOs or Mezz CDOs (Simplified)

ABS CDOs or Mezz CDOs (Simplified) - To continue to attract...

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ABS CDOs or Mezz CDOs (Simplified) Assets Senior Tranche (80%) AAA Mezzanine Tranche (15%) BBB Equity Tranche (5%) Not Rated Senior Tranche (65%) AAA Mezzanine Tranche (25%) BBB Equity Tranche (10%) The mezzanine tranche is repackaged with other mezzanine tranches 1
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Losses to tranches AAA tranche of ABS gets paid as long as losses < 20%. AAA tranche of ABS CDO gets paid as long as losses < 10.25%. 15% of principal goes to ABS mezz. Of that 15%, 35% goes to mezz and equity of ABS CDO. So, need loss > .15*.35 of principal or 10.25% if senior tranche of ABS CDO is to lose. 2
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U.S. Real Estate Prices, 1987 to 2009: 3
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S&P/Case-Shiller Index 4
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What happened… Starting in 2000, mortgage originators in the US relaxed their lending standards and created large numbers of subprime first mortgages. This, combined with very low interest rates, increased the demand for real estate and prices rose.
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Unformatted text preview: To continue to attract first time buyers and keep prices increasing they relaxed lending standards further Features of the market: 100% mortgages, ARMs, teaser rates , . 5 What happened. .. Mortgages were packaged in financial products and sold to investors. Banks found it profitable to invest in the AAA rated tranches because the promised return was significantly higher than the cost of funds and capital requirements were low. In 2007 the bubble burst. Some borrowers could not afford their payments when the teaser rates ended. Others had negative equity. U.S. real estate prices fell and products, created from the mortgages, that were previously thought to be safe began to be viewed as risky. There was a flight to quality and credit spreads increased to very high levels. 6...
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This note was uploaded on 01/19/2012 for the course FIN 4520 taught by Professor Lucyackert during the Spring '12 term at Kennesaw.

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ABS CDOs or Mezz CDOs (Simplified) - To continue to attract...

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