Companion Tranche

AAA

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.




RELATED TERMS
  1. Collateralized Mortgage Obligation ...

    A type of mortgage-backed security in which principal repayments ...
  2. Tranches

    A piece, portion or slice of a deal or structured financing. ...
  3. Prepayment Risk

    The risk associated with the early unscheduled return of principal ...
  4. Planned Amortization Class (PAC) ...

    A class of tranche in a planned amortization class (PAC) bond ...
  5. Targeted Amortization Class - TAC

    A type of credit derivative that is similar to a planned amortization ...
  6. Collateralized Loan Obligation ...

    A security backed by a pool of debt, often low-rated corporate ...
Related Articles
  1. These Financial Products Are Too Complex ...
    Options & Futures

    These Financial Products Are Too Complex ...

  2. Collateralized Debt Obligations: From ...
    Retirement

    Collateralized Debt Obligations: From ...

  3. Why Are Mortgage Rates Increasing?
    Personal Finance

    Why Are Mortgage Rates Increasing?

  4. What is the difference between a collateralized ...
    Investing

    What is the difference between a collateralized ...

comments powered by Disqus
Hot Definitions
  1. Elasticity

    A measure of a variable's sensitivity to a change in another variable. In economics, elasticity refers the degree to which ...
  2. Tangible Common Equity - TCE

    A measure of a company's capital, which is used to evaluate a financial institution's ability to deal with potential losses. ...
  3. Yield To Maturity (YTM)

    The rate of return anticipated on a bond if held until the maturity date. YTM is considered a long-term bond yield expressed ...
  4. Net Present Value Of Growth Opportunities - NPVGO

    A calculation of the net present value of all future cash flows involved with an additional acquisition, or potential acquisition. ...
  5. Gresham's Law

    A monetary principle stating that "bad money drives out good." In currency valuation, Gresham's Law states that if a new ...
  6. Limit-On-Open Order - LOO

    A type of limit order to buy or sell shares at the market open if the market price meets the limit condition. This type of ...
Trading Center