An asset-backed security (ABS) is a type of security that is backed by a
pool of assets. The assets that back ABS can be a variety of types, including
receivables,
loans, or
leases.
ABS is issued by a special purpose vehicle (
SPV), which is a legal entity that is set up specifically to issue ABS. The SPV typically borrows money from investors by selling ABS. The SPV then uses the money to purchase the assets that will back the ABS.
ABS is typically issued with a maturity of more than one year. The interest rate on ABS is typically higher than the interest rate on other short-term debt instruments, such as Treasury bills. This is because ABS is considered to be a riskier investment, as the assets that back ABS do not provide a guaranteed source of repayment for the debt.
ABS is a popular investment for institutional investors, such as money market funds and pension funds. ABS is also a popular investment for corporations, which use it to finance long-term working capital needs.
There are a number of risks associated with ABS, including:
Credit risk: The credit risk of the underlying assets is transferred to the investors. If the borrowers default on their loans, the investors will lose money.
Interest rate risk: The value of ABS can be affected by changes in interest rates. If interest rates rise, the value of ABS will fall.
Prepayment risk: The borrowers may prepay their loans, which can reduce the cash flows to the investors.
Liquidity risk: ABS may be difficult to sell, especially in times of market turmoil.
Despite the risks, ABS can be a valuable investment for institutional investors and corporations. When used properly, ABS can help to improve the efficiency of the financial system and provide investors with access to a wider range of assets.