Tranche

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The word tranche is French for slice.

In structured finance the word tranche refers to one of several related securitized bonds offered as part of the same deal. They are called tranches since each bond is a slice of the deal's risk. The legal documents (see indenture) usually refer to the tranches as "classes" of notes identified by letter (e.g. the Class A, Class B, Class C securities).

All the tranches together make up what is referred to as the deal's capital structure or liability structure. They are generally paid sequentially from the most senior (usually rated Aaa/AAA) to most subordinate (generally unrated), although certain senior tranches with the same rating may be paid pari passu. The deal's indenture (its governing legal document) usually details the payment of the tranches in a section often referred to as the waterfall (because the moneys flow down).

Tranches with ratings of AAA or AA are often referred to as "senior tranches" and are generally safe investments. The natural buyers of these types of securities tend to be conduits, insurance companies, pension funds and other risk averse investors.

Tranches with ratings of A or BBB are often referred to as "mezz tranches" or "mezzanine tranches" and may be able to PIK (pay-in-kind). They are more risky investments and are usually purchased by investors seeking higher returns.

Tranches rated lower than BBB are often referred to as "equity," "pref shares," "income notes," or "residual bonds," depending on the legal structure of the deal. These are highly speculative investments. The natural buyers of these securities tend to be hedge funds and other investors seeking very high return/risk profiles.

One must be very careful investing in structured products. As shown above, tranches from the same offering have different risk, reward, and/or maturity characteristics.