Debt investments are less risky if they are secured bonds. These debentures require an asset or a revenue stream as proof that if there is a default in payment there is something to fall back to. And such assets or revenue streams can be used to recover them. Let’s discuss this in detail.
Definition of Secured Bonds
1. Secured bonds are debt capital that is backed by securities such as a mortgage, shares, other bonds, Properties, Plants, and Equipment (PPE) among others.
2. It can be defined as a debt fund that investors can key into to avoid the risk of default because it is backed by collateral. The reduction of risk means less coupon rate attached to the bond.
Backed by Securities. Secured bonds are backed by securities. What this implies is that such debenture can be refunded with security if the investor or borrower can no longer pay off the debt. This security can be collateral or a revenue stream from an investment.
Collateral securities include a mortgage like real estate. Or if it is a company, the building it acquired. It can be moveable ones like fleets of vehicles owned by the company. Also, plants and equipment can be used as collateral.
Revenue streams are income from an investment. Such investment can be profit from a subsidiary but is tied to the secured bond. Also, it may be on shares or other debentures. For example, a company might pledge shares it acquired from blue-chip stocks as collateral. If the company fails to pay its debts, the bondholders can seize the shares, sell them to recoup the bond.
Reduced risk and interest rate. Secured bonds are less risky. As a result, less interest (coupon) rate. However, their interest rates are higher than government bonds. The reason is that federal government bonds are risk-free. However, secured debenture may face some risk. To illustrate, seizing the pledged assets is not that simple. The investors or bondholders will pay litigation fees. The collateral may be stolen or become obsolete due to changes in technology.
Corporate bond. Most corporate bonds in the bond market are secured bonds. They are tied to an asset of the entity. Others may be unsecured as well. These are tied to the company’s reputation. Read more on corporate bonds here.
In summary, secured bonds are backed by collateral or revenue streams. These securities help to protect against the risk of default. However, war, changes in technology, flooding, litigations among other things may erode security.