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Asset-backed Securities (ABS)
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.
