It stands for tranched portfolio default swap; a variation of collateralized debt obligations (CDOs) in which the exposure to the default swap is divided into tranches (small slices), where the default exposure is linked to the amount of loss. In other words, this swap is based on buying the original loan or asset by a special purpose vehicle (SPV) which then transforms it into notes with different tranches, each of which having a different degree of risk. The SPV uses the swap premium and cash from the sale of tranches to investors to buy a risk-free bond. Therefore, a TPDS differs from a synthetic CDO in that the default swap exposure for the SPV is tranched. Losses on the SPV’s exposure to tranches will be passed on to the investors.

Accordingly, this type of structure allows the default swap buyer (the SPV) to unload, i.e., to partition the risk among many investors. Investors can choose the tranche with a degree of risk reflecting their own risk preference.

This swap is usually structured by banks on specific parts of a loan portfolio in order to embark on an arbitrage opportunity.