TBDS

[higaurav]

Hi David,

In this Q - I am not able to understand that if default correlation is negative then that will mean that we have perfect hedge ..i.e for every one asset defaulting one will not default ...then how is it increases the investment risk..I am not clear, may be missing some conceptual link..pls help

You are considering an investment in the mezzanine tranche of a tranched basket default swap (TBDS)
constructed from a basket of N assets. The TBDS is structured such that the junior tranche is exposed to
the first four defaults, the mezzanine tranche to the fifth, sixth, seventh and eighth defaults, and the
senior tranche to the ninth and higher defaults. The risk of this investment increases as

Rgrds
OM

 

[David Harper CFA FRM]

Hi OM,

It is a very bad question, it surprises me they asked this. The mezzanine cannot be deduced.
About question 31, I assume this is question 31?
Here is prior thread.
And here is post on this.
Recommend you not spend time on this beyond: higher correlation makes senior tranches more likely to default and junior tranches less likely to default.

David