Companion Tranche

Definition of 'Companion Tranche'


A class of tranche found in planned amortization class (PAC) and targeted amortization class (TAC) collateralized mortgage obligations (CMOs) that absorbs variable prepayment rates. The companion trache is so named because it is designed to provide support to the main PAC tranche, which has priority in receiving principal and interest payments so as to give its investors steadier and more predictable cash flows. If the actual rate of prepayments differs from the assumptions made at the time the CMO was issued, the difference is absorbed by the companion tranche.

Also known as a "support tranche".

Investopedia explains 'Companion Tranche'


Prepayment rates on CMOs are significantly affected by interest rates. If interest rates fall, prepayments increase because homeowners refinance existing mortgages at lower rates, shortening tranche life; this is known as contraction risk. Likewise, if interest rates rise, prepayments decrease and the tranche life increases, leading to extension risk.

The companion tranche protects the PAC tranche from contraction and extension risk by absorbing excess principal payments when prepayments increase, and deferring receipt of principal payments when prepayments decrease. This means that the term of a companion tranche itself can vary widely, contracting when interest rates are low and prepayments increase, and extending when interest rates are high and prepayments decrease. Due to this high degree of variability in its cash flows and term, the yield on a companion tranche is higher than on a PAC tranche.



comments powered by Disqus
Hot Definitions
  1. Federal Reserve Note

    The most accurate term used to describe the paper currency (dollar bills) circulated in the United States. These Federal Reserve Notes are printed by the U.S. Treasury at the instruction of the Federal Reserve member banks, who also act as the clearinghouse for local banks that need to increase or reduce their supply of cash on hand.
  2. Benchmark Bond

    A bond that provides a standard against which the performance of other bonds can be measured. Government bonds are almost always used as benchmark bonds. Also referred to as "benchmark issue" or "bellwether issue".
  3. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying a company's shares outstanding by the current market price of one share. The investment community uses this figure to determine a company's size, as opposed to sales or total asset figures.
  4. Oil Reserves

    An estimate of the amount of crude oil located in a particular economic region. Oil reserves must have the potential of being extracted under current technological constraints. For example, if oil pools are located at unattainable depths, they would not be considered part of the nation's reserves.
  5. Joint Venture - JV

    A business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity. In a joint venture (JV), each of the participants is responsible for profits, losses and costs associated with it.
  6. Aggregate Risk

    The exposure of a bank, financial institution, or any type of major investor to foreign exchange contracts - both spot and forward - from a single counterparty or client. Aggregate risk in forex may also be defined as the total exposure of an entity to changes or fluctuations in currency rates.
Trading Center