An asset-backed security is a type of investment that is backed by a physical asset. The most common type of asset-backed security is a mortgage-backed security, which is backed by a pool of mortgages. Other types of asset-backed securities include auto loan-backed securities, credit card receivables-backed securities, and student loan-backed securities.
Asset-backed securities are created when a lender loans money to a borrower and then sells the loan to an investor. The investor then receives periodic payments from the borrower, which are typically interest payments. The investor also receives the principal amount of the loan when it is paid off.
Asset-backed securities offer a number of benefits to investors. First, they provide a steady stream of income, which can be attractive to investors who are looking for a reliable investment. Second, asset-backed securities are typically less risky than other types of investments, such as stocks and bonds. This is because the underlying asset serves as collateral for the loan, which reduces the risk of default.
Asset-backed securities are not without risk, however. The most common risk is prepayment risk, which occurs when the borrower pays off the loan early. This can reduce the return on investment for the investor, as they will not receive the full amount of interest payments. Additionally, if the underlying asset decreases in value, the investor may not be able to recoup their investment.
Asset-backed securities can be divided into two main categories: residential and commercial. Residential asset-backed securities are backed by mortgages on homes, while commercial asset-backed securities are backed by loans on commercial properties, such as office buildings and shopping centers.
Asset-backed securities have been around for centuries, with the first recorded instance in 1609. However, it was not until the 1970s that they began to be used in large scale. In the 1980s, the use of asset-backed securities expanded beyond the United States, and by the 1990s they had become a global phenomenon.