A tranche (CDO tranche) of a synthetic CDO; a structured product that is based on an underlying portfolio of equally weighted reference entities (reference pool) subject to credit risk. The pattern of realized cumulative default losses on the reference pool (credit portfolio) determines the cash flows of such a tranche.

Default losses are allocated to various tranches in accordance with certain thresholds (attachment points and detachment points/ exhaustion points). In other words, a synthetic CDO tranches is a type of credit derivatives where the credit risks correspond to a reference pool and the risk range is clearly set for the tranche. An attachment point is the lower bound of the risk range and a detachment point is the upper bound. In this sense, a synthetic CDO tranche is equivalent to a credit default swap (CDS), where a fixed premium spread is contractually determined as the price of the credit risk associated with the referenced tranche.

A CDO tranche with specific parameters (attachment point, detachment point and maturity) constitutes a bilateral contract involving two parties: a protection seller and a protection buyer. The cash-flows correspond to the default payment leg (payments received by the protection buyer) and the premium payment leg (CDO tranche premium, the fixed payments received by the protection seller).

For example, a 4%-8% tranche is defined by risk range of 4% (an attachment point of 4%) and 8% (a detachment point of 8%). When the accumulated loss of a reference pool is, or is less than, 4% of the pool’s notional, the tranche will have no risk exposure. However, when the loss exceeds 4%, additional losses will affect the tranche’s notional up to the level of the detachment point, 8%, at which point, the tranche is said to be wiped out.

Synthetic CDO tranches may be either funded or unfunded (funded synthetic CDO tranches and unfunded synthetic CDO tranches).