Tranche loss scenarios, calculation

Step 4 Calculate Tranche Loss Scenarios. Calculate the probability of each loss scenario for each tranche using a binomial distribution. Calculate the amount of loss for each tranche in each scenario. 

Note holders expected losses are determined by considering the impact on their cash flows of the credit losses—losses from loan defaults— occurring in various scenarios, taking into account how such losses are allocated to the issue s tranches. The cash flows to the note holders depend on whether a default has occurred and the size of the resulting loss. The severity of the loss equals the par value of the note less the recovery rate. The probability of default may be inferred from the rating of the underlying credit exposures. Expected losses are calculated using Monte Carlo techniques, which simulate thousands of scenarios and cash flows and so require sophisticated computational models. 

Step 5 Rate and Price Tranches. Evaluate the probability-weighted losses in each scenario to generate an overall expected loss for each tranche, and from this expected loss calculate an implied rating for the tranche. Price the tranche based on spreads for comparably rated investments. Having determined the cost of each ratable liability tranche, estimate the available excess spread applicable to the (unrated) equity tranche. 

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See also in sourсe #XX -- [ ]

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