ABS (Asset-Backed Securities)

Asset-backed securities (ABS) are financial instruments created by pooling various income-generating assets, such as loans or receivables, and repackaging them into tradeable securities. Like a basket woven by a skilled artisan to carry a diverse array of goods, ABS transform illiquid assets into marketable securities that can be bought and sold by investors, allowing for the diversification of risk and the creation of new investment opportunities.

Example

A bank may originate a large number of auto loans, each with varying interest rates and maturities. To reduce its exposure to risk and free up capital for additional lending, the bank may pool these loans and create an ABS. The cash flows generated by the auto loans, such as principal and interest payments, are then used to pay the investors who purchase the ABS. The creation and sale of ABS can help financial institutions manage risk, diversify their balance sheets, and enhance liquidity in the market for various types of assets.