Questions 3 -5:

Assume CDO's collateral consists of a pool of non-callable bonds that all mature in 5 years, pays the 5-year US Treasury rate plus100 bps, and has a par value of $80 million. The senior tranche consists of 40% of the pool and pays EOIA (European Overnight Index Average) plus 30 basis points; the mezzanine tranche consists of 35% of the pool and pays the 5-year treasury rate plus 250 basis points. Assuming that none of the bonds in the pool will default, a 5-year Treasury rate at 5%at settlement, and servicing fees of $1M (deducted from the net interest earned by the CDO),

3. the maximum return to the equity tranche closest to:

A.7.02%

B.7.20%

C.8.02%

4. Which of the following interest swap agreement would give the CD0 manager the best hedge against interest rate risk?

A. Notional of 32M, pay LIBOR +30 BPS, receive EOIA

B. Notional of 32M, pay 3%, receive EOIA+100 BPS+

C. Notional of 80M, pay EOIA+70 BPS, receive 4%

5. Given the answer to question 4, with the appropriate interest rate swap, the return to the equity tranche is closest to

A. 4.82%

B.5.28%

C.6.02%