Tranche Math

The targets of about 9% for Senior and about 32% for Junior come from the model on this page. Here is the model, then what happens in weaker and stronger weeks.

The model's assumptions

  • A $10m pool: $8.5m Senior (85%) and $1.5m Junior (15%).
  • $30,000 of gross option premium in a week, about 15.6% a year gross on the pool.
  • The protocol fee at 20%, because the Insurance Fund is below its target.
  • Treasury bill yield on idle cash left out, for simplicity. In practice it adds to the pool's yield.

A normal week, step by step

StepSeniorJunior
1. Gross premium $30,000; protocol fee 20% ($6,000); $24,000 remains
2. Senior priority: 7% a year on $8.5m, divided by 52 weeks$11,442
3. The excess of $12,558 split 25% / 75%$3,139$9,418
Total for the week$14,582$9,418
Annualized (the week's income × 52, divided by the tranche's balance)about 8.9%about 32.7%

Weak, normal and strong weeks

Same pool, different premium. The Senior rate and Junior rate columns annualize the week: its income times 52, divided by the tranche's balance.

WeekGross premiumAfter 20% feeSenior getsJunior getsSenior rateJunior rate
Weak$12,000$9,600$9,600$0about 5.9%0%
Normal$30,000$24,000$14,582$9,418about 8.9%about 32.7%
Strong$45,000$36,000$17,582$18,418about 10.8%about 63.9%

These are illustrations of the model, not forecasts. Real premium varies week to week with market conditions.

In the weak week the pool earns less than Senior's 7% priority, so Senior takes everything and Junior earns nothing. In the strong week, most of the extra goes to Junior. That is the trade: Junior's income swings much more than Senior's.

When the Insurance Fund is at target

While the Insurance Fund holds at least 2% of the pool, the protocol fee drops to 10%. In the normal week, $27,000 would remain after the fee instead of $24,000, and the extra $3,000 would be split 25% / 75% like any other excess.