Test Bank: Chapter Securitization and the Credit Crisis of 2007 Suppose that ABSs are created from portfolios of subprime mortgages with the following allocation of the principal to tranches: senior 75%, mezzanine 20%, and equity 5% An ABS CDO is then created from the mezzanine tranches with the same allocation of principal Losses on the mortgage portfolio prove to be 16% What, as a percent of tranche principal, are losses on (i) The equity tranche of the ABS (ii) The mezzanine tranche of the ABS _ _ _ _ _ _ (iii)The senior tranche of the ABS _ _ _ _ _ _ (iv)The equity tranche of the ABS CDO _ _ _ _ _ _ (v) The mezzanine tranche of the ABS CDO (vi)The senior tranche of the ABS CDO Which of the following would tend to lead to an increase in house prices (Circle two) (a) A reduction in interest rates (b) Regulators specifying a maximum level for the loan-to-value ratio on mortgages (c) Banks reducing the minimum FICO that borrowers are required to have (d) An increase in foreclosures When a mortgage is non-recourse (Circle one) (a) The house buyer can lose all possessions if he or she is unable to make payments (b) The purchaser has a free American style put option on the house (c) The purchaser has a free European style put option on the house (d) The lender is less likely to lose money on the mortgage Which of the following is not true (Circle one) (a) The bonus structure at banks is liable to lead to short term horizons for decision making (b) A portfolio of BBB tranches created from mortgages has a loss probability distribution similar to a portfolio of BBB bonds (c) The term “agency costs” describes the situation where the incentives of two parties in a business relationship are not perfectly aligned (d) Correlations tend to increase in stressed market conditions