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Tranche

A tranche is a portion or slice of a pooled collection of securities, typically found in structured finance products like collateralized debt obligations (CDOs) or mortgage-backed securities (MBS). Each tranche has different risk levels, returns, and repayment schedules. Senior tranches receive payment first and are considered safer, while junior or equity tranches have higher risk but offer potentially higher returns.

Example

In a mortgage-backed security, the highest-rated tranche (senior tranche) is paid first and is considered the safest, while the lowest-rated tranche (equity tranche) is the last to be paid and carries the most risk.

Key points

• A portion of a structured financial product divided by risk and return.

• Senior tranches receive payments first and are less risky, while junior tranches offer higher risk and potential rewards.

• Common in mortgage-backed securities and collateralized debt obligations.

Quick Answers to Curious Questions

Tranches allow investors to choose different risk and return profiles based on their investment preferences, enhancing the flexibility of the product.

Senior tranches are paid first and have lower risk, while junior tranches are paid last and carry higher risk but offer higher returns.

By dividing the product into tranches, different levels of risk are distributed among investors, allowing more risk-averse investors to focus on safer tranches.