What are asset-backed securities (ABS) backed by?

Asset-backed securities (ABS) are financial instruments that are created by pooling various types of loans, leases, or credit card debt and then selling shares of this pool to investors. The cash flows generated from these underlying assets—such as mortgage payments, auto loans, or credit card payments—serve as the primary source of revenue for the ABS. This structure provides a way for companies to raise capital by using the future income from these assets, allowing investors to receive periodic payments based on the performance of the underlying loan portfolio.

The significance of this structure lies in the risk management and liquidity it offers. By converting illiquid assets into tradable securities, ABS can enhance market efficiency and provide investment opportunities that are often backed by consumer debt.

The other options do not accurately describe what ABS are backed by. Government bonds represent a form of debt issued by a governmental entity, not by loans or leases. Physical commodities consist of tangible items like gold or oil, which are unrelated to the financial practices of pooling loans for ABS. Lastly, the foreign exchange markets deal with the trading of currencies and do not involve asset-backed securities at all. Therefore, the correct understanding of ABS revolves around the loans, leases, or credit card debt that underpins these financial instruments.