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In investing, asset-backed commercial paper refers to investments that use the issuing company’s assets as collateral. These are usually short-term investments, with maturities of nine months or less. Like all commercial paper, asset-backed commercial paper is usually discounted, or priced at less than face value. When the paper matures, the investor who bought it gets the face value. The difference between the discounted sale price and the investment's face value represents the investor’s return. Because they are backed by assets of the issuing company, they tend to be less risky than some other types of investments.
Asset-backed commercial paper could be a collateralized debt obligation (CDO) or a collateralized mortgage obligation, or CMO. Each of these instruments is backed by a pool of assets with different levels of risk. A CDO is typically backed by bonds or loans. A CMO is backed by mortgages. By using a variety of assets, the risk is spread out over the entire pool, reducing the impact of the potential default of any one loan. A CDO or CMO is known as a pass-through security, as the loan payments, after the deduction of fees, are passed through to the investors.
In the United States, government sponsored enterprises are some of the largest issuers of asset-backed commercial paper. The Federal National Mortgage Association, also known as FNMA or Fannie Mae, issues CMOs that it guarantees. The Federal Home Loan Mortgage Corp., sometimes called FHLMC or Freddie Mac, also creates and guarantees mortgage-backed securities. The Government National Mortgage Association, also called GNMA or Ginnie Mae, doesn’t issue CMOs, but it does guarantee them. A Ginnie Mae bond is backed by the full faith and credit of the U.S. Government, making it a virtually risk-free investment.
When an economy experiences a credit crisis, such as the one in the United States in the fall of 2008, it can be difficult or impossible for a company to issue asset-backed commercial paper. Since commercial paper is often used to finance a company’s day to day operations, this kind of credit crisis can severely impact a company’s ability to do business. When this occurred in the United States in 2008, the government created the Commercial Paper Funding Facility, or CPFF, to provide liquidity to companies who were unable to issue the commercial paper they needed. Longer-term investments received similar treatment from the Money Market Investor Funding Facility, or MMIFF. The Primary Dealer Credit Facility, or PDCF, was also created to allow dealers to borrow overnight with sufficient collateral.
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