A tranche is a group of securities that have the same priority of payment. It is sometimes referred to as a "slice" or a "class".
Tranches are used to divide the cash flows from the underlying assets into different risk classes. This allows investors to choose the tranche that best suits their risk appetite.
There are typically three types of tranches in a securitisation:
- Senior tranches: Senior tranches have the highest priority of payment. This means that they will receive their payments first, even if the underlying assets default.
- Mezzanine tranches: Mezzanine tranches have a lower priority of payment than senior tranches. This means that they will receive their payments after the senior tranches, but before the junior tranches.
- Junior tranches: Junior tranches have the lowest priority of payment. This means that they will receive their payments last, and they may not receive any payments if the underlying assets default.
The different tranches are typically priced differently, with the senior tranches being priced at a lower yield than the mezzanine tranches and the junior tranches. This is because the senior tranches have the lowest risk, while the junior tranches have the highest risk.
Tranches can be used to:
- Manage risk: Tranches can be used to manage risk by dividing the cash flows from the underlying assets into different risk classes. This allows investors to choose the tranche that best suits their risk appetite.
- Create new products: Tranches can be used to create new securitization products that meet the needs of different investors. For example, an issuer may issue a securitization with a different number of tranches, or with different priorities of payment.
- Reduce costs: Tranches can reduce the costs of securitization by allowing the issuer to sell different tranches to different types of investors. This is because different types of investors have different risk appetites, and they are willing to pay different prices for the different tranches.
Tranches are a valuable tool for securitisation. They can be used to manage risk, create new products, and reduce costs.