Asset-Backed Commercial Paper

Long term investments always provide more security and a peace of mind that investors rely on. However, short term investments can be taken advantage of as well, when done properly. One of the ways that many investors invest in short term options is by purchasing asset-backed commercial paper. Asset-backed commercial paper is a short term investment that usually holds a maturity level anywhere from 90 days to 180 days. They are issued by banks and other types of financial institutions. The value of asset-backed commercial paper investments is backed by physical assets. One of the types of physical assets used to back up these types of investments is trade receivables.

Asset-backed commercial paper, or ABCP, is brought into existence by companies that are looking to raise their liquidity levels. Companies sell their receivables to banks and other financial institutions that they then offer to investors. The commercial paper is then backed by the amount of cash flow that is generated from the investments with receivables. The investors, or the note holders of asset-backed commercial paper, are then passed the funds from the bank or financial institution that collects the receivables. However, since asset-backed commercial paper investments are design for short term investment strategies, they present a certain amount of higher risks than traditional investments do.

The underlying securities associated with asset-backed commercial paper are perceived to be riskier than traditional commercial paper investments. Traditional commercial paper investments are backed by companies that offer promissory notes as a way of showing obligation to the investors. In order to grasp the amount of risk involved with asset-backed commercial paper, the investor must understand the value of the underlying assets that back up the investment. Specific conduits are used to generate ABCP investments. These conduits include SIVs, single and multi-seller and security arbitrage. Under certain economic conditions, SIVs present bigger risks than other types of conduits.

Each conduit presents different opportunities that will be the deciding factor for investors when choosing which direction to take. Multi and single seller conduits are appealing for investors who are looking to invest in companies that are interested in funding new mortgage loans. The housing market alone can affect these investments that overall effect the value of asset-backed commercial paper investments. Investors who are not interested with investing in new mortgages should avoid multi and single seller conduits. This is just one example of how the many different conduits will dictate the investor’s decision on how to invest in asset-backed commercial paper.

SIVs, also known as structured investment vehicles, are a different type of conduit altogether. SIVs actually issue asset-backed commercial paper. Large financial institutions such as commercial banks administer SIVs. Commercial banks issue ABCPs to fund their purchasing power towards investment grade securities. Triple “A” and double “A” assets can be found in commercial bank portfolios. These assets can also include mortgage-backed securities as well. The complex relationship between the assets, the issuer of SIVs and new mortgages creates a pool of risks that many inexperienced investors tend to avoid.

If the market value drops, and the assets are affected and also drop in value, then liquidity risk comes into play. Normally, there would be no liquidity risks involved in this situation but asset-backed commercial paper investments have a direct relationship with its underlying assets. Investors who are skittish about the current housing market should stay away from these types of investments. However, the recent low housing prices present a wide variety of opportunities for investors. When the housing market reaches an all time low, the only direction prices can move is up. These assets that gain value will produce significant returns to investors who purchased asset-backed commercial paper.

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