When you hear secured bonds, you must be thinking that such loans or bonds must be safe or the payments of secured loans or secured bonds will be secured by some kind of security.
Well, that is the most straightforward understanding of what a secured bond can mean.
But do you know how secured bonds work? What are the types of secured bonds? The return a secured bond can generate, why you should invest in them and the risks these bonds hold?
Let’s dive deep into the term, ‘secured bonds’ and find answers to the questions mentioned above.
Secured Bond: Meaning and Example
As the name suggests, the issuer of a secured bond will provide an asset it owns as a security to protect the bondholder’s interest. The advantage of a secured bond is that the bondholders will get their money even if the issuer defaults in repayment as the issuer provides security.
Since the issuer’s assets secure the bonds, these debt instruments are relatively safer than equity instruments.
The most common type of secured bond is a corporate bond and sovereign bond.
Types of Secured Bonds
Essentially, there are two types of secured bonds: Corporate Bonds and Sovereign Bonds,
1. Corporate Bonds
Corporate secured bonds are issued with a security that could be in a form of any high value machinery or a factory or a warehouse or hypothecation on current assets of the company.
Investors can use the security to claim their investment repayment in case the company defaults in making the payment.
2. Sovereign Bonds
Sovereign bonds are issued by the Government either in local currency or in foreign currency. The Government issues such bonds to raise capital for development of the country or to repay any old debt.
The interest rate of a sovereign bond is decided based on the creditworthiness of the issuing Government. Usually, since the Government issues such bonds, they are considered safe.
Why Should You Consider Investing in Secured Bonds?
Here are a few reasons why you should consider investing in secured bonds:
1. Safer than Equity
One of the major advantages of investing in a secured bond is that they are relatively safer than equity and provide security against failure to repay the invested amount.
2. Fixed Income
Secured bonds offer regular fixed income to the investor, although the interest rates can be lower, as compared to equity.
3. Efficient Cash Flow Management
Since secured bonds are asset-backed and offer regular income, they provide investors with a steady cash flow to manage their cash flow more efficiently.
4. Avail Loans
You can use secured bonds to provide as collateral to the bank while applying for loans.
5. Get Equity Rights
Convertible secured bonds can be converted into equity. This can eventually increase your earning potential.
Risks Involved in Investing in a Secured Bond
These bonds involve specific risks that you must know of before investing in them and in case of borrower default, the money would be realised post the bankruptcy proceedings of the entity (this process can take time).
- You may lose your money if the collateral becomes unsaleable or its value drops in the market;
- If the issuer of the bond offers collateral with the intention of fraud, you may lose your money in such a case.
- The interest rate fluctuations in the economy will affect the value of the bond in the secondary market and it can change if someone is looking to sell it before maturity and if someone holds the bonds till maturity, the coupon and principal will be paid;
- These bonds come with a lock-in period, and you might not be able to redeem them. In such a case, you can face a liquidity risk where your money will be stuck when you need it.
- From historical data, it has been seen that very rarely do investors get loans against bonds and adding to that, convertible secured bonds are also issued rarely.
Also, note that the secondary market for these bonds is limited so one should invest with the intention of holding till maturity.
Secured bonds are starting to become popular in the debt market due to the security they offer, and the interest rates are also high. You can add secured bonds to diversify your portfolio.
However, your risk appetite, financial goals, and interests are the major deciding factors before investing in any security.