Triple A Rated Mortgages: Most people who are investing their money want to do so at a very limited risk. For this reason many pension funds and mutual funds require that any stock or bond purchased has to be rated to have an very low risk of going into default. Standard and Peors (S&P) and Moody are two companies who rate the risk of investments and their triple A ranking is supposed to indicate that the bond has a risk of less that 1 irn 850(0.12%) of going into default. 4. It is rather difficult to find individual investments which are this conservative in their risk. Therefore, it is common practice on Wall Street to bundle together a bunch of risker investments into what are called Collateralized Debt Obligations (CDO's). The idea is that these bonds pay out as long as not every loan in the bundle fails (a) What is the risk of a CDO failing to pay out if it consists of 10 loans which all independently have a probability of 5% of failing individually? (b) If we are trying to bundle together subprime loans which each have a probability of 50% of failing into a triple AAA CDO how many loans do we need to put into the CDO? (c) What is the probability the subprime CDO will fail to pay out if the loans used in the bundle are completely dependent on one another? (d) Do you expect that mortgage loan foreclosures are completely independent of one another? This error by the ratings agencies was a major contributing factor in the recent global economic meltdown