Posted in Finance, Accounting and Economics Terms, Total Reads: 290
Definition: Companion Tranche
Companion tranche is a type of tranche that is used to absorb the volatility that may arise due to fluctuations in the payback of mortgages. It is to ensure that the lending firm doesn’t get hit badly because of the change in interest rate regime in that particular market.
If the interest rates fall, there will be a lot of prepayments and loan readjusting that shall take place. This leads to shortening of the tranche life. This is termed as contraction risk. The companion tranche protects from contraction risk by absorbing the excess principal payments during a cut in Interest rates.
Basically, if the actual rate of pre-payment differs from that planned; the difference is absorbed and adjusted by Companion tranche to ensure steadier cash flows to its investors.
It is also known as “Support Tranche” and is mainly used for Planned Amortization Class.