How do the tranches attract different “types” of investors?
Explain. CDOs offer diversification in risk by pooling underlying collateral risk profiles and yielding a single risk-return profile on the underlying pool of assets. Basically, tranches create different classes of securities that each carry a different component defined by its payment history and timing. In a traditional structure, there will be an AAA or AA senior tranche, a BBB or BB mezzanine tranche and an equity tranche. Investment grade tranches are usually overcollateralized, which is the practice of posting more than adequate collateral, often to obtain a high debt rating from a credit rating agency, or to comfort a creditor. [3] Tranches attract different types of investors based on how risk sensitive they are. For example, highly rated securities will have a lower return and can appeal to institutional investors like pension funds. Lower-rated securities will have a higher return and can appeal to hedge fund managers who are willing to sacrifice safety for the juicier yields
