GLOSSARY oF FINANCIAL TERMS AAA rating The highest available rating from a credit rating agency, Structured Product representing the lowest credit risk of any class of debt securities. For our purposes, a bond backed by a pool of assets, such as mortgages. For example, the AAA tranches of a mortgage-backed security, a CDO, or a CDO squared are the highest rated, lowest risk tranches. Mortgage-Backed Securities The mortgages are pooled into Mortgage-Backed Securities. By the numbers Investors buy tranches of the securities Take a hypothetical $750 million mortgage-backed security backed by The mortgages are Financial pooled into 5,000 subprime mortgages of $150,000 each. Typically, about 80% or Financial institution Mortgage-Backed $600 million of these subprime mortgage-backed securities are rated AAA. institutions fund holds many Securities home purchases mortgages AA 5,000 mortgage loans of $750 million $150,000 each = mortgage-backed $750 million Investors buy security tranches of Homeowners securites sign mortgage Tranche The word tranche is French for slice, section, series, or portion. A 80% AAA $600 tranche is a portion of a structured product created such that each million divided into multiple tranches that have different risk characteristics. portion hasPool the of same cash �low characteristics.Tranches A structuredLower product yield is mortgage loans Lower risk AA and $150 20% lower tranches million AAA Now, if you take the CDO BBB and lower AAA AA tranches and repackage them into AAA A a CDO with other other AA BBB and lower and BBB tranches, over 83% AAA lower BB- Higher yield tranches unrated Higher risk or nearly $630 million of the CDO original $750 million other AA AA and A structured product which gives the bond holders the right to receive in mortgage-related and lower lower tranches the assets has now been AAA tranches backed securities. A CDO is divided into multiple tranches that have translated into differentcash �lowsrisk characteristics. from a pool of other securities – often including mortgage AAA-rated bonds. 2 CDO (or CDO squared) Now, if you take the AA and A tranches of the CDO and repackage them into A structured product which gives the bond holders the right to receive a CDO squared with other AA and A tranches, over 84% or nearly $635 the million of the original $750 million in mortgage-rated assets has now been translated into AAA-rated bonds. cash �lows from a pool of tranches of different CDOs.