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ASSET BACKED SECURITY

An asset-backed securityis asecuritywhose income payments and hence value is derived

from and collateralized (or "backed") by a specified pool of underlyingassets.The pool of

assets is typically a group of small and illiquid assets which are unable to be sold

individually. Pooling the assets into financial instruments allows them to be sold to general

investors, a process calledsecuritization, and allows the risk of investing in the underlying

assets to be diversified because each security will represent a fraction of the total value of the

diverse pool of underlying assets. The pools of underlying assets can include common

payments from credit cards, auto loans, and mortgage loans, to esoteric cash flows from

aircraft leases, royalty payments and movie revenues.

Often a separate institution, called aspecial purpose vehicle, is created to handle the

securitization of asset backed securities. The special purpose vehicle, which creates and sells

the securities, uses the proceeds of the sale to pay back the bank that created, or originated,

the underlying assets. The special purpose vehicle is responsible for "bundling" theunderlying assets into a specified pool that will fit the risk preferences and other needs of

investors who might want to buy the securities, for managing credit risk often by

transferring it to an insurance company after paying a premium and for distributing

payments from the securities. As long as the credit risk of the underlying assets is transferred

to another institution, the originating bank removes the value of the underlying assets from its

balance sheet and receives cash in return as the asset backed securities are sold, a transaction

which can improve itscredit ratingand reduce the amount of capital that it needs. In this

case, a credit rating of the asset backed securities would be based only on the assets and

liabilities of the special purpose vehicle, and this rating could be higher than if the originating

bank issued the securities because the risk of the asset backed securities would no longer beassociated with other risks that the originating bank might bear. A higher credit rating could

allow the special purpose vehicle and, by extension, the originating institution to pay a lower

interest rate (and hence, charge a higher price) on the asset-backed securities than if the

originating institution borrowed funds or issued bonds.

Thus, one incentive for banks to create securitized assets is to remove risky assets from their

balance sheet by having another institution assume the credit risk, so that they (the banks)

receive cash in return. This allows banks to invest more of their capital in new loans or other

assets and possibly have a lower capital requirement. This should not be regarded as money

laundering.

An "asset-backed security" is sometimes used as an umbrella term for a type of security

backed by a pool of assets,[1]and sometimes for a particular type of that security one

backed by consumer loans[2]or loans, leases or receivables other than real estate.[3]In the first

case,collateralized debt obligations(cdo, securities backed by debt obligations often other

asset-backed securities) andmortgage-backed securities(mbs, where the assets are

mortgages), are subsets, different kinds of asset-backed securities. (Example: "The capital

market in which asset-backed securities are issued and traded is composed of three main

categories: ABS, MBS and CDOs". (italics added)[4]). In the second case, an "asset-backed

security" or at least the abbreviation "ABS" refers to just one of the subsets, one backed

http://en.wikipedia.org/wiki/Security_(finance)http://en.wikipedia.org/wiki/Security_(finance)http://en.wikipedia.org/wiki/Security_(finance)http://en.wikipedia.org/wiki/Assethttp://en.wikipedia.org/wiki/Assethttp://en.wikipedia.org/wiki/Assethttp://en.wikipedia.org/wiki/Securitizationhttp://en.wikipedia.org/wiki/Securitizationhttp://en.wikipedia.org/wiki/Securitizationhttp://en.wikipedia.org/wiki/Special_purpose_vehiclehttp://en.wikipedia.org/wiki/Special_purpose_vehiclehttp://en.wikipedia.org/wiki/Special_purpose_vehiclehttp://en.wikipedia.org/wiki/Credit_ratinghttp://en.wikipedia.org/wiki/Credit_ratinghttp://en.wikipedia.org/wiki/Credit_ratinghttp://en.wikipedia.org/wiki/Asset-backed_security#cite_note-1http://en.wikipedia.org/wiki/Asset-backed_security#cite_note-1http://en.wikipedia.org/wiki/Asset-backed_security#cite_note-1http://en.wikipedia.org/wiki/Asset-backed_security#cite_note-vink-2http://en.wikipedia.org/wiki/Asset-backed_security#cite_note-vink-2http://en.wikipedia.org/wiki/Asset-backed_security#cite_note-vink-2http://en.wikipedia.org/wiki/Asset-backed_security#cite_note-investopedia-3http://en.wikipedia.org/wiki/Asset-backed_security#cite_note-investopedia-3http://en.wikipedia.org/wiki/Asset-backed_security#cite_note-investopedia-3http://en.wikipedia.org/wiki/Collateralized_debt_obligationhttp://en.wikipedia.org/wiki/Collateralized_debt_obligationhttp://en.wikipedia.org/wiki/Collateralized_debt_obligationhttp://en.wikipedia.org/wiki/Mortgage-backed_securitieshttp://en.wikipedia.org/wiki/Mortgage-backed_securitieshttp://en.wikipedia.org/wiki/Mortgage-backed_securitieshttp://en.wikipedia.org/wiki/Asset-backed_security#cite_note-4http://en.wikipedia.org/wiki/Asset-backed_security#cite_note-4http://en.wikipedia.org/wiki/Asset-backed_security#cite_note-4http://en.wikipedia.org/wiki/Asset-backed_security#cite_note-4http://en.wikipedia.org/wiki/Mortgage-backed_securitieshttp://en.wikipedia.org/wiki/Collateralized_debt_obligationhttp://en.wikipedia.org/wiki/Asset-backed_security#cite_note-investopedia-3http://en.wikipedia.org/wiki/Asset-backed_security#cite_note-vink-2http://en.wikipedia.org/wiki/Asset-backed_security#cite_note-1http://en.wikipedia.org/wiki/Credit_ratinghttp://en.wikipedia.org/wiki/Special_purpose_vehiclehttp://en.wikipedia.org/wiki/Securitizationhttp://en.wikipedia.org/wiki/Assethttp://en.wikipedia.org/wiki/Security_(finance)

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by consumer-backed products, and is distinct from a MBS or CDO, (example: "As a rule of

thumb, securitization issues backed by mortgages are called MBS, and securitization issues

backed by debt obligations are called CDO .... Securitization issues backed by consumer-

backed products car loans, consumer loans and credit cards, among others are

calledABS

... (italics added)

[2][5]

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