If a tranche spread is 55 basis points and the fixed coupon is 60 basis points, which of the following happens when a trader buys protection?
A. The trader pays an estimate of the present value of 5 basis points per year and then pays 55 basis points per year
B. The trader pays an estimate of the present value of 5 basis points per year and then pays 60 basis points per year
C. The trader receives an estimate of the present value of 5 basis points per year and then pays 55 basis points per year
D. The trader receives an estimate of the present value of 5 basis points per year and then pays 60 basis points per year
D
Trading is organized so that the trader pays 60 basis points. Because the spread is actually only 55 basis points the trader receives an estimate of the present value of 5 basis points per year at the outset. This means that the tranche trades like a bond.
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