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The Tranche structure

Greatly facilitates the creation and hedging of CDOs

Require highly sophisticated models to value and trade

Have complex interrelational dynamics

Default and Recovery assumptions key

Correlation:

Default correlation among constituent reference credits key valuation assumption

INCREASE in correlation

INCREASE expected losses in Senior tranches

»

So value of protection increases

DECREASE expected losses in Equity tranche

»

So value of protection decreases

Credit Indices

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