Pass-Through Security

Categories: Banking, Bonds

Think of a mob boss putting money into front companies. A criminal with a bunch of extra cash buys a laundromat and puts the business under his cousin's name. The cousin owns the laundry. But he sends the mob boss his cut every week...or else. The mob boss doesn't own the business; his deal is that he's entitled to some of the cash.

A pass-through security operates in a similar fashion. A group of assets are pooled together. You buy a pass-through security based on those assets. The revenue generated passes through a third-party administrator (often the issuer of the security) to you and the rest of the PTS holders.

Mortgage-backed securities represent the most prominent example of these forms of investment. An MBS is comprised of a basket of underlying mortgages. A bank (or other financial institution) acquires a bunch of similar mortgages. It then issues tradable securities based on those mortgages.

These investments become the pass-through securities. Holders of the MBS are entitled to a portion of the revenues generated from those mortgages. (Unless, of course, it's 2008, and the MBS market goes south and everyone starts checking to see if their life insurance policies cover self-harm).

Related or Semi-related Video

Finance: What are Passive Investing and ...2 Views

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finance a la shmoop what is passive investing and/or passive investors

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all right well passive investing is all about I give you money you give me back [people exchanging money]

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more than this money some years from now like passive investing is that cheque

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written to a venture capital fund is a limited partner not at all involved in [hand writing check]

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the daily operations of the fund when you buy a hundred shares of Pepsi you're

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passively investing in it index funds yep also passive here you're a passive [Pepsi stock transfer]

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investor in them and the funds themselves are generally passive as well

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yes share counts are tweaked regularly but in very small relative amounts so [share counter]

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that they conform to whatever guidelines were promised to investors when they

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invested and index funds generally barely even vote on proxies or comment

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much if at all on management policy of the companies in which they invest so

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they just kind of sit there as placeholders like a lot of congressmen [people sitting down in meeting]

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passive investing also lives inside of ETFs or exchange-traded funds where

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initially a bundle of stocks is picked and well more or less nothing happens [basket full of stocks]

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with them subsequently other than that they move around a lot right they don't

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tweak in the way they do index but all right again passive okay so then what's

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active well active investing is just the opposite that is the investor gets all

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up in management's face they push for policy changes and board influence and

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other things notionally set to make the company worth more to its shareholders [money dropped onto table]

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they actively research the company they actively check out the industry in the

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margin structure and the revenue growth in the global 'no sand the policy [clip board check list]

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changes legally in blah blah blah blah blah so that's passive and active

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investing but there's also a notion of passive and active income and that

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carries a very big difference meaning passive income is income you get from

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investment gains like what we just described either index funds or actively

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managed mutual and hedge funds all that kind of stuff make investment gains from

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that since you're not doing it all day unless you're a professional money [men at computer]

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manager and then that's different but if you're not doing it all day well then [woman fanning herself on porch]

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it's passive income to you those dividends that get thrown off from all

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those oil stocks yeah of income to you that bond interest

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coming to you twice a year a thousand dollar bond and pay 6% you get 30 bucks

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for yeah passive income okay got it well so then what's active income and why

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does that even matter well it rhymes with sh max's yeah the tax treatment is

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very different for passive income versus active income and generally speaking

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passive investment gains are taxed at investment rates ie you held that

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investment for over a year and if you did well then your tax it usually a much

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lower rate or long-term gains rates like 20-ish percent maybe 25 30 if you're in

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a blue states right they tack on the state taxes on top of it oh yeah and [map of USA]

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then there's Obamacare as well alright but that's passive investment made from

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long term gains realization like you buy stock at 20 you sell it at 30 you

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realize 10 bucks a share in gains got it okay but then there's active income and

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that comes from hauling bricks all day that brick hauling thing you get taxed [woman throwing bricks]

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at very high ordinary income rates because hauling bricks well you ever

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done it is an active act and it hurts your back well you're performing it in

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order to win your daily bread or doughnut as it were and the government

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feels that well when you're working hard you should be taxed at a higher rate

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which really encourages people to you know improve their call of duty skills [man with gun]

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well the key notion behind passive investing in passive investors

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that'll work hard earn your money save your savings and then let your money

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work for you so you can then be really passive [woman on porch drinking punch]

Find other enlightening terms in Shmoop Finance Genius Bar(f)