Definition
Asset-Backed Security (ABS) is a type of financial instrument backed by a pool of assets, such as loans, leases, credit card receivables, or mortgages. The cash flows from these underlying assets are used to pay interest and principal to investors.
Why It Matters
ABS instruments provide liquidity to lenders and diversify investment options for investors. They allow banks and financial institutions to convert illiquid assets into tradable securities, support credit markets, and spread financial risk across participants.
Example
A bank bundles hundreds of auto loans into an ABS. Investors who purchase the ABS receive payments derived from the borrowers’ loan repayments, while the bank obtains capital to issue new loans.