Tranche

A tranche is a portion, slice, or class of a pooled collection of securities, typically in structured products like CDOs or mortgage-backed securities. Tranches are differentiated by risk, return, maturity, and payment priority. For example, a $100 million MBS might have: Senior tranche (70%, rated AAA, lowest yield), Mezzanine tranche (20%, rated BBB, medium yield), and Equity tranche (10%, unrated, highest yield). Senior tranches receive payments first and have lowest default risk, while equity tranches absorb first losses but offer highest potential returns. This structure, called subordination or waterfall, allows different investors to choose risk levels matching their preferences. During the 2008 crisis, even senior tranches of subprime MBS experienced losses, challenging assumptions about tranche safety. Tranching enables efficient risk distribution but can obscure true risks if underlying assets are correlated. Modern regulations require clearer tranche disclosure and risk retention by originators.