Credit enhancement
Credit enhancement provides support intended to absorb losses or improve payment reliability for a particular claim. Examples include subordination of junior notes, excess collateral or a third-party guarantee, subject to the transaction's terms. Its effectiveness depends on the scale of losses, counterparty strength, legal enforceability and priority rules. Enhancement can change how risk is distributed among investors; it does not make the underlying assets or the transaction free of risk.
Worked example
A securitisation allocates the first $10 million of qualifying pool losses to a junior tranche before a senior tranche is affected. This provides limited subordination support to the senior holders under the agreed waterfall.
Common mistake
Treating a guarantee as risk-free when the guarantor can default, or assuming enhancement protects against losses beyond its contractual coverage.
Where it appears in your exams
| Qualification | Exam | Relationship | Period |
|---|---|---|---|
| ACCA | AFM | Direct | September 2026–June 2027 |