As the loss to the tranche increases, the premium notional of the tranche decreases and hence the premium payment decreases. The buyer of a CDS on a tranche will be compensated by the seller for any loss to the tranche and in return he/she pays periodic premium to the seller. Like a single-entity CDS, a CDS on a CDO tranche has a payoff leg and a premium leg. They can be viewed as extensions of the corresponding single entity credit default swaps and credit-linked notes. The most commonly used credit derivatives in synthetic CDOs are credit default swaps (CDSs on CDO tranches) and tranche-linked notes (CDO notes). However, when the loss has exceeded 5%, any further loss will be deducted from the tranche’s notional until the detachment point, 10%, is reached.

When the accumulated loss of the reference pool is no more than 5% of the total initial notional of the pool, the tranche will not be affected. For example, a 5-10% tranche has an attachment point of 5% and a detachment point of 10%. The lower bound of the risk level of a tranche is often referred to as an attachment point and the upper bound a detachment point. The risk range of two adjacent risk levels is called a tranche. The level with a higher credit risk supports the levels with lower credit risks. To download the latest trial version of FINCAD Analytics Suite, contact a FINCAD Representative.Ī common structure of CDOs involves slicing the credit risk of the reference pool into a few different risk levels. Other (non-standard) single tranche CDOs are often called bespoke tranches. The reference credit pools of such CDOs are CDS indices, such as CDX and ITRAXX series.

The most popular single tranche CDOs are exchange traded standardized tranches.

Single tranche CDOs have been developing rapidly for the last few years and are the most popular synthetic CDOs currently in the market. Such CDOs are thus sometimes called single tranche CDOs. They can be customized so that the payment structure of a tranche doesn’t depend on the payment structures of other tranches. Most synthetic CDOs in the market do not have a so-called cash flow waterfall structure. Such reference entities can be bonds, loans or simply names of companies or countries. Synthetic collateralized debt obligations (CDOs) are credit derivatives that are 'synthesized' through credit derivatives, such as credit default swaps (CDSs), on a pool of reference entities.

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