What Are Tranches? Definition, Meaning, and Examples

A tranche is a portion or slice of a pooled collection of financial instruments, such as loans or mortgages, that are structured to divide risk or investment return among different investors. Tranches are a common financial structure for securitized debt products, such as a collateralized debt obligation (CDO), which pools together a collection of cash flow-generating assets—or a mortgage-backed security. Each tranche has its unique characteristics, including varying levels of risk, return, and priority in the payment structure. Tranches are typically used in the credit and debt markets in a process called securitization, which divides up various types of debt instruments and packaged into funds to be sold to investors who want to earn the interest rate on the debt. Tranches can also be miscategorized by credit rating agencies. If they are given a higher rating than deserved, it can cause investors to be exposed to riskier assets than they intended to be. Such mislabeling played a part in the mortgage meltdown of 2007 and the subsequent financial crisis. Tranches containing junk bonds or sub-prime mortgages (below-investment-grade assets) were labeled AAA or the equivalent, either through incompetence, carelessness, or, as some charged, outright corruption on the agencies' part...