What is: Asset-Backed Security (ABS)

What is Asset-Backed Security (ABS)

An Asset-Backed Security (ABS) is a type of financial security that is backed by a pool of assets, such as loans, leases, or receivables. These assets are typically grouped together and sold to investors as a single security. ABS are often used to securitize assets that generate cash flows, such as mortgages or credit card receivables.

ABS are structured in a way that allows investors to receive payments based on the cash flows generated by the underlying assets. This structure helps to reduce risk for investors, as the cash flows from the assets are used to make payments on the ABS. In the event that the underlying assets default, investors may incur losses.

One of the key features of ABS is the process of securitization, which involves transferring the ownership of assets to a special purpose vehicle (SPV). The SPV then issues securities that are backed by the assets, which are sold to investors. This process helps to create a diversified pool of assets, which can help to reduce risk for investors.

ABS can be structured in a variety of ways, depending on the type of assets backing the security. For example, mortgage-backed securities (MBS) are a type of ABS that are backed by a pool of mortgage loans. Other types of ABS include collateralized debt obligations (CDOs) and asset-backed commercial paper (ABCP).

Investors in ABS receive payments based on the cash flows generated by the underlying assets. These payments may include interest and principal payments, depending on the structure of the security. ABS are often rated by credit rating agencies, which assess the creditworthiness of the underlying assets and the structure of the security.

Overall, ABS are a popular investment vehicle for investors seeking exposure to a diversified pool of assets. By securitizing assets and selling them to investors, ABS help to increase liquidity in the financial markets and provide opportunities for investors to earn returns on their investments.