Fixed Income Qbank Question receives, structure, investor, indicate

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The most popular form of credit enhancement is the senior-subordinated structure. What does the senior-subordinated collateral structure shown below indicate?

Senior tranche: $560 million

Subordinated tranche: $40 million


A) The subordinated tranche investor receives $40 million in repayment first. Then the cash flow goes to the senior tranche.
B) The subordinated tranche is protected by the senior tranche.
C) The first $40 million of losses are absorbed by the subordinated tranche.

Your answer: A was incorrect. The correct answer was C) The first $40 million of losses are absorbed by the subordinated tranche.

The loss of $40 million is applied to the subordinated tranche first and since it is large enough to absorb the entire loss, all $40 million is applied to the subordinated tranche.

***From my understanding, the subordinate layers of the tranche absorb the prepayment of principle first, and therefore bear more of the reinvestment risk then higher level tranches. So how is choice C better than choice A?

FYI i went through both Schweser and CFAI and could not find anything on credit risk or losses related to tranches of a CMO. Only that the reinvestment risk is different for the different levels. Any thoughts??? Thanks!