A tranche is one of an array of related securities (security issues), each of which is characterized by different return patterns, cash flows, strike price, and expiration date. However, each tranche (or slice) is offered as part of the same structure/ transaction. For the purpose of documentation, a tranche is a different “class” of securities, each identified by its own letter, and corresponds to its own credit rating. Tranches are created by means of structured finance, for multiple ends and purposes, including better segregation of risk and improved cash flows, all in a manner that appeals to various groups of investors.
On the other hand, a tranchelet is a portion of a tranche (a further tranched tranche) that constitutes a non-standard CDO tranche (or other types of tranches) with smaller loss intervals in comparison with standardized tranches. Tranchelets are thinner slices forming narrower intervals such as 0-1%, 1-2%, etc.
A tranchelet is designed to fine-tune investors’ positions as to the exposures held. A tranche consists of at least two tranchelets, where the risk in all the component tranchelets has to add up to the tranche’s risk. For example, if if a tranche is set at 3% of a pool, individual tranchelets have to add up to 3% (e.g., tranchelet 1 is 1%, tranchelet 2 is 2%, and so on.)
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