Suppose that a bank has a mortgage-backed security with a total principal of $5 million and monthly payments of $30,000. They wish to bundle it and are considering two possible divisions:

1.Two tranches, each paying 15,000 per month

2.Two tranches, the senior paying 20,000 per month and the junior paying 10,000

This question will ask about these 4 tranches, which you can abbreviate as 1-senior, 1-junior, 2-senior, and 2-junior.

a.Rank the 4 tranches in order of their probability of default (i.e. the likelihood that it will not be paid in full). Explain your rationale.

b.Rank the 4 tranches in order of the price it would take to buy 1,000/month in payments from that tranche. Explain your rationale.