Credit Risk Management Practice Exam

Which term describes a funding instrument secured by a portfolio of assets?

1. Collateralized Loan Obligation (CLO)

2. Securitized Mortgage Bond

3. Asset-Backed Security (ABS)

4. Covered Bond

The correct answer is: Covered Bond

The term that accurately describes a funding instrument secured by a portfolio of assets is Asset-Backed Security (ABS). ABS are financial instruments created from multiple underlying assets, such as loans, leases, credit card debt, or receivables. These assets are pooled together and then sold to investors, who receive income based on the cash flows generated by the underlying assets. The key attributes of ABS include their backing by a diversified pool, which helps mitigate individual asset risk, and their structured nature, allowing for various tranches that cater to different risk appetites. Collateralized Loan Obligations (CLOs) are a specific type of ABS that focus primarily on a pool of loans, typically corporate loans. Securitized Mortgage Bonds are also specific and generally involve mortgage loans, while Covered Bonds are unique in that they are backed by a dual recourse mechanism, explicitly tied to both the issuer and a specific pool of assets, functioning somewhat differently than typical ABS. Thus, the broader term capturing a range of asset-backed financial instruments is indeed Asset-Backed Security, making it the most fitting choice for the question posed.