Consider a collateralized debt obligation (CDO) that has a $250 million structure. The collateral consists of bonds that mature in 7 years and the coupon rate for these bonds is the seven-year Treasure rate plus 500 basis points. The senior tranche comprises 70 percent of the structure and has a floating coupon of LIBOR plus 50 basis points. There is only one junior tranche that comprises 20 percent of the structure and has a fixed coupon of seven-year Treasury rate of 300 basis points. Compute the rate of return earned by the equity tranche in this CDO if the seven-year Treasury rate is 6 percent and the London Interbank Offered Rate (LIBOR) is 7.5 percent. There are no defaults in the underlying collateral pool. Ignore the collateral manager’s fees and any other expenses
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