Asset-Backed Security (ABS)

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Definition of 'Asset-Backed Security (ABS)'

An asset-backed security (ABS) is a type of security that is backed by a pool of assets, such as loans, receivables, or other financial instruments. ABSs are often issued by special purpose vehicles (SPVs), which are legal entities that are created specifically to issue ABSs. The SPVs typically sell the ABSs to investors and use the proceeds to purchase the underlying assets.

ABSs are often used to securitize illiquid assets, such as mortgages or student loans. This allows investors to gain exposure to these assets without having to purchase them directly. ABSs can also be used to transfer credit risk from one party to another. For example, a bank may sell an ABS backed by its mortgages to a third party, which would then assume the credit risk associated with the mortgages.

ABSs are a relatively complex financial instrument, and there are a number of risks associated with them. These risks include credit risk, interest rate risk, and liquidity risk. Credit risk is the risk that the underlying assets will default, which could lead to losses for investors. Interest rate risk is the risk that interest rates will change, which could affect the value of the ABSs. Liquidity risk is the risk that there will be insufficient buyers for the ABSs if the issuer wants to sell them.

Despite the risks, ABSs can be a valuable investment tool for investors who are looking for a way to gain exposure to illiquid assets or transfer credit risk. However, it is important to understand the risks associated with ABSs before investing in them.

Here are some additional details about ABSs:

* ABSs are typically rated by credit rating agencies, such as Moody's and Standard & Poor's. The rating of an ABS reflects the credit quality of the underlying assets and the structure of the ABS.
* ABSs can be traded in the secondary market, just like other types of securities. The price of an ABS will fluctuate based on the market conditions and the credit quality of the underlying assets.
* ABSs are a relatively new financial instrument, and they have been used in a variety of ways. In recent years, ABSs have been used to securitize a wide range of assets, including mortgages, student loans, credit card receivables, and auto loans.

ABSs can be a complex financial instrument, but they can also be a valuable investment tool. It is important to understand the risks associated with ABSs before investing in them.

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