Asset-backed Securities

An asset-backed security (ABS) is a tradable financial instrument that’s created by pooling income-generating assets and selling them on to investors. Think of it like this:

  • A company (like a bank) has a bunch of loans it’s issued (e.g., car loans, invoices).
  • These loans generate regular cash flow (payments from borrowers).
  • The company groups these loans together and creates a security backed by the expected future cash flow from those loans.
  • This security, the ABS, is then sold to investors who receive a portion of the cash flow generated by the underlying assets.

Key points to remember:

  • The underlying assets can be various things, but they all generate cash (e.g. car loans, invoices, business loans, etc.).
  • ABS allows companies to free up capital on their balance sheet by selling the future income stream from the assets.
  • Investors benefit from potentially attractive returns and diversification in their portfolio.