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Postby anbu.edu » Sat Nov 01, 2014 8:21 am

Can anybody help me understand attachment and detachment points in MBS- with an example

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Postby edupristine » Tue Nov 04, 2014 7:56 am

The first step in creating a single-tranche synthetic CDO is to determine an underlying portfolio. The second step is to determine the size and subordination of the single tranche to be created.

A tranche’s “attachment point” defines the amount of losses in the reference portfolio where losses begin to accrue to the tranche. In other words, it defines the tranche’s subordination level.

Likewise, a tranche’s detachment point defines the maximum amount of losses in the reference portfolio that can be absorbed by the tranche. Hence, the difference between the tranche’s detachment point and the attachment point together defines its size (i.e., its notional amount).

The following example illustrates single-tranche synthetic CDOs.

Tranches A and B both reference a $1.25 billion portfolio of 125 investment-grade corporate obligations. Both tranches have a notional amount of $25 million, or 2% of the reference portfolio. The only difference between the two tranches is the level of subordination.

Tranche A’s attachment point is 5.5%, meaning that it starts to absorb losses after the portfolio losses exceed 5.5% of $1.25 billion, or $68.75 million.

Tranche B, on the other hand, starts to absorb losses before Tranche A, with subordination of just
4.5%, or $56.25 million ( = 4.5% x $1.25 billion).

Obviously, Tranche B is riskier than Tranche A, and while Tranche A is triple-A rated, Tranche B is double-A rated. Naturally, spreads would be wider for Tranche B.

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