What is a tranche?
Meaning ‘portion’ or ‘slice’ in French, the word tranche in financial circles refers to a security that can be split into smaller pieces and subsequently sold to investors. The term is often used to describe a specific class of bond where each tranche has a varying degree of risk attached to it.
Where have you heard about tranches?
You may recognise the term from 2015 movie The Big Short, or articles on the sub-prime mortgage crisis. The word is also used when talking about the portions of bailout cash handed out to Greece by the Eurozone.
What you need to know about tranches.
Mortgage-backed bonds, such as collateralised mortgage obligations (CMO), often come in tranches. These securities are split based on when they mature, such as in 2 years or 25 years, and then sold to investors based on their risk tolerance.
One investor might need cash in the short term only, while another might only want cash in the long term. To take advantage of this, an investment could split some assets, such as a CMO, into different parts so the first investor receives the early cashflows of a mortgage and the second investor has the right to receive the later cashflows. Dividing a financial product into parts can increase its saleability.
Find out more about tranches.
Watch Ryan Gosling’s hilarious explanation of tranche in The Big Short: https://www.youtube.com/watch?v=3hG4X5iTK8M.