Suppose that the structure in Figure 8.1 is created in 2000 and lasts 10 years. There are no defaults on the underlying assets until the end of the eighth year when 17% of the principal is lost because of defaults during the credit crisis. No principal is lost in the nal two years. There are no repayments of principal until the end. Evaluate the relative performance of the tranches. Assume a constant LIBOR rate of 3%. Consider both interest and principal payments.

Figure 8.1 An asset-backed security (simplified); bp basis points (1 bp = 0.01%). Asset 1 Asset 2 Asset 3 Senior tranche Principal: 580 million LIBOR-60 by SPV Mezzanine tranche Principal: $15 million LIBOR-250 bp Asset Principal: $100 million Equity tranche Principal: $5 million LIBOR +2,000 bp Figure 8.1 An asset-backed security (simplified); bp basis points (1 bp = 0.01%). Asset 1 Asset 2 Asset 3 Senior tranche Principal: 580 million LIBOR-60 by SPV Mezzanine tranche Principal: $15 million LIBOR-250 bp Asset Principal: $100 million Equity tranche Principal: $5 million LIBOR +2,000 bp