Calculate the expected Return on Equity for the equity tranche in the first two years of 4 year CLO.

Calculate the expected Return on Equity for the equity tranche in the first two years of 4 year CLO.

Information:

•  $1 billion dollar pool
•  Fee are 2% of FV in each year and are paid the end of the year
•  Recovery from defaults is invested at 5%. It is invested immediately.
• The defaults occur at the beginning of the second-half of each year.
•  The annual interest on the pool of loans (i=8%) is paid semiannually and is based on the remaining balance of loans in the pool.
•  Losses are not reduced from equity until the end of the CLO.

Year 1: Default 3% / Recovery 60%

Year 2: Default 8% / Recovery rate 40%

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