Asset-backed Security

An asset-backed security (ABS) is a bond backed by a pool of financial assets which may include credit card payments, trade receivables and a variety of loans. A special class of asset-backed security are mortgage-backed securities. The utility of an asset-backed security is that it enables holders of illiquid assets, such as commercial banks, to bring them to market. An asset-backed security is synthesized in a process called securitization. An asset-backed security is created as the underlying mortgages, loans etc... are sold off to an investment vehicle, which in turn issues the asset-backed security representing those obligations in the form of a bond. The benefit of an asset-backed security is that it enables the issuer to transfer any risk inherent to the underlying pool of funds to whomever buys the ABS. Additionally, an asset-backed security can enable the issuer to borrow funds more cheaply than by issuing a traditional bond. This is because an asset-backed security derives its credit rating from the creditworthiness of the underlying assets, not the financial solvency of the issuing firm, as with traditional bonds.