Asset-Backed Security (ABS)

An asset-backed security (ABS) is a financial instrument backed by a pool of underlying assets, typically loans, leases, credit card debt, or receivables. These assets are bundled together and sold to investors in the form of securities. The income generated from the underlying assets is used to pay interest and principal to the ABS holders. Asset-backed securities are commonly used to transfer risk from the originators of the loans (such as banks) to investors. ABS offers investors the opportunity to earn returns based on the cash flows from the underlying assets while providing liquidity to the originators.

Example

A common type of ABS is a mortgage-backed security, where the underlying assets are home loans. Investors receive payments derived from the mortgage payments made by homeowners.

Key points

• A financial instrument backed by a pool of underlying assets like loans or receivables.

• Provides returns to investors based on the cash flows from these assets.

• Used to transfer risk from loan originators to investors.

Quick Answers to Curious Questions

How do asset-backed securities work?

Investors in ABS receive payments from the cash flows generated by the underlying assets, like loans or leases, in the form of interest and principal.

What are the risks of investing in ABS?

The risk depends on the quality of the underlying assets and the structure of the security. If the underlying loans default, the value of the ABS could decline.