8m 64k example connued if one default end poriolio

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Unformatted text preview: knowing the default dependency structure of the securi:es in the underlying porIolio, is extremely important for valua:on A hugely oversimplified example •  PorIolio of 10 one- year bonds, $200K each. –  Either repaid with 5% interest at the end of the year, –  Or defaults with 100% loss. –  Default probability: 0.1 for each. •  Senior tranche: 60% of capital, 3%/yr interest. •  Junior tranche: 40% of capital, 8%/yr interest. •  If no defaults, $100K in interest is earned. –  Senior tranche earns 3% of 1.2M = 36K –  Junior tranche earns 8% of 0.8M = 64K Example, con:nued •  If one default, end porIolio value is 9*200K*1.05 = 1.89M. •  If senior tranche’s interest is more senior than junior tranche’s capital, then –  Senior tranche must get 1.2M*1.03 = 1.236M –...
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This note was uploaded on 05/28/2012 for the course ECE 695 taught by Professor Staff during the Spring '08 term at Purdue University-West Lafayette.

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