Since the mid-18th century one of the most significant innovations in the financial world was creation of asset-backed securities (ABS), which were represented by the mortgage-backed securities (MBS) in the United States where farm railroad mortgage bonds were issued. Since then, many other types of derivative products were created in an attempt to enhance risk transfer between market participants by securitizing assets or cash-flows. As a result of the advancements in structured products, global OTC derivatives market has grown from nearly US$ 80 trillion in 1998 to almost US$ 700 trillion at the peak in 2011, and slightly over US$ 500 trillion in 2017, which is 6x times greater than global GDP according to IMF.
Despite the importance and size of global derivatives market, and continuous developments, there has been little change to the actual structure of derivatives, as most of them either split
pooled assets or
pooled cash-flows from the groups of assets using different types of combination of forward commitments or contingent claims with slightly modified parameters.
Distributed Ledger Technology (DLT) promised to innovate and revolutionize the financial industry. However, since the creation of Bitcoin, there has been little innovation in area of financial instruments on their own, but mostly implementation of technology in various fields of finance, thus creating the FinTech hype.
With the emergence of
FinTech, people forgot about the
“Fin” aspect, and focused entirely on the
“Tech” part. There have been dozens of new projects that promised to bring new derivatives to the capital markets, however, all they have done was taking traditional financial products from capital markets, and implementing them in the digital asset space.
However, the most recent financial innovation could be
Tranched Value Securities (TVS) [patent pending], first described in the
SSRN manuscript.
With this thread we will try to provide a few key points on what is TVS, how to estimate its payouts, how to use them, and what are their benefits.
WHAT IS A TRANCHED VALUE SECURITY (TVS)
“Tranched Value Security (TVS) [patent pending] is a security whose income payments, and hence value is derived from and collateralized (or "backed") by the value of a single asset, group of assets, stream of cash-flows or any other entity or product possibly having a determinable value (and / or price). Value of TVS is derived either from a value share of a specific underlying, or from a minimum contract value, which can equal to the value share of a specific underlying at the contract initiation, given that a higher-level (or “prior”) TVS are satisfied.”
In easier terms, TVS is similar to asset-backed security (ABS), but while the later one splits a
pool of assets or
pool of cash-flows,
TVS splits the value.
It can be easier understood by looking at the CDO mortgage-backed security (MBS) representation from IMF below:
In the diagram above, for any ABS (RMBS (Residential Mortgage Backed Security) in this case), you would need a number of mortgages in order to create a pool of cash-flows, diversify risks, split the pool based on risk/return, and sell pool tranches to investors with appropriate risk/return appetites.
MBS Example:- You have 10 mortgages, each making $10 payment every month (ignore maturity for now), which is 10 x $10 = $100 monthly;
- With RMBS, a banker would securitize these mortgages and create SPV (Special Purpose Vehicle) that would be collecting these $100;
- SPV would issue various securities and sell those securities to external investors, who can be getting mortgage-backed payouts.
For simplicity assume, the banker creates 3 tranches:
• Senior tranche (ST): receives $50 fixed, first in a row to receive payouts
• Mezzanine tranche (MT): receives $30 fixed, second in a row to receive payouts after the ST
• Junior tranche (JT): receives $20 or whatever left after the ST and MT received their payouts
With such structure, Senior would be priced highest, as it’s first in the row to receive payouts (thus, less risk), and JT would be prices with greatest discount (higher risk / higher return).
If everything goes as planned: three tranches receive what they need to and everyone is happy.
If some mortgages make overpayments: some mortgages make payouts of $15 (prepayment risk – not typically desirable by the ST holders), the extra $5 gets absorbed by the JT (extra return).
If some mortgages default: the JT absorbs the losses first. If two or more mortgages stop paying – JT doesn’t get anything, and then MT might also get nothing.
With TVS, only one mortgage would be enough, to do exactly the same. While 1 mortgage could be making payouts of $100 monthly, at some periods of time it could be paying more or less, and those under-/over-payments could be assigned to the riskier part of payouts pool. It can well be 5 mortgages, or 117.89321 Bitcoins, or 3 T-Bills, or 99 stocks of Apple – as long as the underlying asset has a determinable value, the value can be securitized and TVS can be issued.
TVS Example:- You have 1 Bitcoin, having a value / price of $100;
- With TVS, a banker would securitize this 1 Bitcoin and create SPV (Special Purpose Vehicle) that would be absorbing Bitcoin value;
- SPV would issue various securities and sell those securities to external investors, who can redeem their newly issued securities value at any point in time.
For simplicity assume, the banker creates 3 value tranches:
• Senior tranche (ST): receives $50 fixed or 50% or Bitcoin value (whatever is greater), first in a row to receive payouts
• Mezzanine tranche (MT): receives $30 fixed or 30% of Bitcoin value (whatever is greater), second in a row to receive payouts after the ST
• Junior tranche (JT): receives $20 or 20% of Bitcoin value (whatever is greater) or whatever left after the ST and MT received their payouts
If Bitcoin price goes up forever linearly without any single decline – the three tranches perform as if they are same shares with 100% same returns. Once Bitcoin price starts declining and then subsequentially changing price – TVSs have different return profiles.
Imagine after issuing TVS, Bitcoin declines to $95 (-5% return):ST: can get 50% of $95 or $50 => $50
(0% return)MT: can get 40% of $95 or $40 => $40
(0% return)JT: should get 20% of $95 or $20 =>
$20, but that would not be possible, as there’s no value left that can be paid out, therefore, JT gets $95 - $50 - $40 = $5
(-75% return)Holder of JT decides that it’s too much risk for him as Bitcoin might decline further and sells it to another investor for $5.
Imagine after that, Bitcoin increases to $110 (+15% return):ST: can get 50% of $110 or $50 => $55
(+10% return)MT: can get 40% of $110 or $40 => $44
(+10% return)JT: should get 20% of $110 or $20 => $22
(+340% return) Thus, by securitizing the value, Tranched Value Security transformed the performance of derivatives backed by the same underlying and issued on the same date.
TVS PAYOUT MODEL
Based on the above example, the generalized version of TVS payouts can be represented as below:
While the above model represents a valid payout model for TVS, the proper pricing model of TVS is still work in progress to be done. Therefore, every trader and user of TVS needs to study the presented derivative thoroughly and make informed decision about how to price it and what to trade it for.
IMPORTANT FEATURES OF TVS
• Variable Value Share (VVS): the share represented in % terms which can be claimed by the TVS holder based on the asset price, given that the claims of more senior TVSs have been satisfied
• Fixed Value Share (FVS): the fixed dollar value which can be claimed by the TVS holder based on the asset price, given that the claims of more senior TVSs have been satisfied
• Underlying Asset: any asset or cash-flow with determinable value that was securitized based on which TVS was issued
From the MBS-type of products the following features can be implied: • Attachment Point (AP): the amount by which the underlying asset needs to decline in price in order for the current TVS to start declining in price (if TVS has AP of 10%, it will not lose anything until asset (Bitcoin) declines by at least 10%; once it declines by 10% or more – current TVS also declines)
• Detachment Point (DP): the amount by which the underlying asset needs to decline in price in order for the current TVS to lose all value (if TVS has DP of 10% and asset (Bitcoin) declines by 10% or more – current TVS is priced at $0)
0. For TVS to function as assumed, there must be at least 2 TVSs for any specific underlying asset when its securitized
1. Sum of all TVSs’ VVS must always equal to 100%
2. Sum of all TVSs’ FVS must always equal to the full price of underlying asset
3. If 1. or 2. are not satisfied, arbitrage opportunities might be present
4. While the payout model dictates that TVS might have a price of $0.00, it’s unrealistic assumption as the $0.00 TVS might turn out to be highly valuable if the underlying asset subsequently increases in value, and giving TVS for $0.00 means giving future upside potential for free (as previously $0.00 TVS increases in value it can be redeemed for actual asset, such as Bitcoin (would you give it for free?
)); therefore, initially arbitrage opportunities are expected with TVS model
5. Due to 4. your will never get liquidated position with TVS as with leveraged trading or margin trading6. Attachment Point < Detachment Point
HOW TO USE TVS
Tranched Value Securities are a new type of financial instruments, therefore might hinder yet to be discovered risks. However, here we want to highlight only a few strategies that you could implement with TVS.
You have Bitcoin and expect its price to declineStrategy: Securitize your Bitcoins, and sell Junior tranches
Example:• Bitcoin cost $100 now
• You have 1 Bitcoin
• You assume Bitcoin will decline by 20%
• You securitize your Bitcoin and issue 2 TVSs (for example), where:
- The Senior TVS has VVS of 80% and FVS of $80
- The Junior TVS has VVS of 20% and FVS of $20
• You sell Junior TVS and get $20
• If Bitcoin declines in value by anything less than 20%, your Senior TVS remains at least at $80 (Junior TVS absorbs losses first)
• If Bitcoin increases in value, your Senior TVS increases as well
You have Bitcoin and expect its price to increaseStrategy: Securitize your Bitcoins, and sell Senior tranches, and buy more Junior tranches
Example:• Bitcoin cost $100 now
• You have 1 Bitcoin
• You assume Bitcoin will increase by 20%
• You securitize your Bitcoin and issue 2 TVSs (for example), where:
- The Senior TVS has VVS of 80% and FVS of $80
- The Junior TVS has VVS of 20% and FVS of $20
• You sell Senior TVS and get $80
• With $80 you buy more of Junior TVSs
• If Bitcoin increases in value your initial Junior TVS will increase by 20% proportionally, but the Junior TVS you bought from others will increase even more
• If Bitcoin decreases in value, you might become a holder of temporarily $0 value TVS (which is not realistic as described above)
You don’t have Bitcoin and expect its price to declineStrategy: Buy Senior TVS from other people
Example:• Bitcoin cost $100 now
• You want to invest in it but don’t want to lose
• You assume Bitcoin will decline by 20%
• You buy TVS from others with Attachment Point of at least 20.0000…01%
• If Bitcoin declines by anything less than 20.0000…01%, your TVS remains at least at what you bought it for
• If Bitcoin increases in value, your TVS increases as well
You don’t have Bitcoin and expect its price to increaseStrategy: Buy Junior TVS from other people
Example:• Bitcoin cost $100 now
• You want to invest in and earn more than the market, but don’t want to take leverage
• You assume Bitcoin will increase by 20%
• You buy any kind of Junior TVS from others (the more junior – the higher the potential, the more risk)
• If Bitcoin increases by any amount – you earn more than the market
• If Bitcoin decreases by at least as much as the Attachment Point of your TVS – you start losing, if Bitcoin deceases by your Detachment Point or more - you become a holder of temporarily $0 value TVS (which is not realistic as described above)
You want to hold a portfolio of TVS for future upsideStrategy: Buy Junior TVSs from various dates of issuance
Example:• Bitcoin cost $100 now, $90 tomorrow, and $120 the next day
• Two other traders securitized their 1 Bitcoin on the first two dates above, and issued same 2 TVSs with VVS of 50%, but first TVS has FVS of $50, and second one has FVS of $45
• You buy the first Junir TVS for $50
• Tomorrow your TVS becomes $40 (-20% return), and you buy another Junior TVS from the second trader for $45
• The next day your first Junior TVS becomes $60 (
+20% 2-day return,
+50% 1-day return), the second Junior TVS also becomes $60 (
+33 1-day return)
• In total you have spent $85, and after 2 days earned $120, meaning
+41% total return, while Bitcoin
increased by +20% over the same period
You want to hold a portfolio of TVS for future downsideStrategy: Buy Senior TVSs from various dates of issuance
Example:• Bitcoin cost $100 now, $90 tomorrow, and $80 the next day
• Two other traders securitized their 1 Bitcoin on the first two dates above, and issued same 2 TVSs with VVS of 50%, but first TVS has FVS of $50, and second one has FVS of $45
• You buy the first Senior TVS for $50
• Tomorrow your TVS remains at $50 (
0% return), and you buy another Senior TVS from the second trader for $45
• The next day your first Senior TVS remains at $50 (
0% 2-day & 1-day return), the second Senior TVS remains at $45 (
0% 1-day return)
• In total you have spent $85, and after 2 days it stayed at $85, meaning
0% total return, while Bitcoin
decreased by -20% over the same period
WHERE TO LEARN MORE ABOUT TVS
About Tranched Value Securities (TVS) Tranched Value Securities CalculatorTranched Value Securities Original Manuscript on SSRNLesson 1: as.exchange Tranched Value Securities (TVS) vs. Spot TradingHappy to hear all your comments and feedback! Hope this will help you in managing risks and improving returns.
If you think this thread is worth being translated in your own local board, please do so! We will be happy to provide assistance!
DISCLAIMERS
This post is not intended to serve as advertisement or promotion of as.exchange or Alter Securities Limited, or any of their services or products, but only for educational purposes about Tranched Value Securities.
as.exchange is a trademark of Alter Securities Limited ("The Company"). The Company has filled a patent application with the World Intellectual Property Organization (WIPO) for the Tranched Value Securities™ (the “TVS™”) instrument. The current status of the patent is patent pending, therefore, any use or reference to the Tranched Value Securities™ might be subject to the local patent laws and regulars and should be done after the official approval from the Alter Securities Limited. Unauthorized use or implementation without the Alter Securities Limited consent, reference to or commercialization of Tranched Value Securities™ is subject to legal proceedings and financial penalties.
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