Bond Type: Junior versus Senior Bonds

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•Purpose: to apportioned more credit risk to the junior piece

•Method: creating an internal credit enhancement

•Effect: reducing costs

By splitting a bond into two tranches, a junior bond with higher credit risk and a senior bonds with a lower credit risk, the issuer is able to offer the necessary risk reward payoffs to two sets of distinct investors. The first, which is risk adverse and the other who is risk preferring.  The design of such structuring is an internal credit enhancement and therefore offers the least costs to the issuer.

The risk reward payoff to the investors are as follows:

1.Junior bond holders usually get a higher coupon. However, in event of difficulties, they may not be paid even if the senior bond holders get paid i.e. they take first loss.

2.If the senior bond holders get paid but not the junior bond holders, generally it is do deemed as an event of default.