In the world of finance and investments, a specific part of a larger transaction is referred to as a tranche. The word tranche is actually a French word, and it is translated into English as a “portion” or “part.” Usually Tranches are used as a means of assuring investors of some sort of regularity in the payment of premiums on the investment in such larger transactions as collateralized mortgage obligations.

Function of Tranche

If someone is willing to understand the function of the tranche, it is helpful to see a large transaction as containing a subset of components, having investors funding the activity a little at a time. In these types of transactions it is a rare case if investors pay a lump sum in return for their share of investment in the security. Instead of that, they will pay in portions that are sometimes known as staged investments or tranches.

Example of how tranche works

An excellent example of how a tranche works is the purchase and resale of bank instruments by a trading group. The purchase of instruments is made in blocks, with commitments to eventually purchase all outstanding blocks named within the contract.

The purchase of the initial block might only be a fraction of the total cost for the contracted amount of shares, but the purchase of other blocks will be made at specified times for the duration of the contract.

Simultaneously, the purchaser of the blocks can be reselling the bank instruments, doing this they cover the purchase price of the block and usually make a profit as well. By this the purchaser is allowed to cover the cost of the next scheduled purchase of a tranche, and in turn he repeats the sale process.

Securitized bonds

By using a tranche approach the securitized bonds are often structured. The securitized bond issue may be of such a size that to buy and sell in portions not only work, but it is also favorable. When they are structured properly, then the end result can bring profit for both the issuers of the bonds as well as the entities that purchase and resell the portions of the bond.

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