Bonds are a type of debt instrument that is issued by large corporations or government agencies with the purpose of raising capital. It doesn't matter who is issuing it, a bond can be classified into one of two categories. It can be either secured or unsecure in nature. Investors need to know the differences between these two types. Investors should research the risk-to-reward ratio and the pros and cons of investing in either category.
A'secured bond is one that is backed up by an asset class. This bond may be backed by physical assets such as property, machinery, plants or stock. Secured bonds allow bondholders to claim any assets backing the bond in the event that the issuer fails to pay its principal or coupon.
Let's say, for example, that a hypothetical government agency issues bonds to finance an infrastructure project. This could be a highway construction project. The income generated from the collection of toll fees that all motorists will pay for that highway can be used to secure bonds. This secure arrangement of receiving payments makes the bond more secure for all stakeholders. These secured bonds are known as revenue bonds.
There are many other types of secured bonds. A corporate structure can offer real estate as collateral to be used as collateral. These secured bonds are also known as mortgage bonds. If the corporate defaults in its principal payments, coupons, or both, bondholders can foreclose on collateral property to recover their dues.
Secured vs. unsecured bonds are different because the former can be backed by assets, while the latter cannot. Unsecured bonds can also be called debentures. If the issuer of these bonds becomes bankrupt or defaults on its payments to shareholders, then the shareholders are not guaranteed the repayment of principal and interest. Because there is no future income stream or asset that could serve as collateral, this is why the bond is 'unsecured'. The bond is therefore 'unsecured'.
Unsecured bonds can be seen as notes, corporate bond, Treasury bills and many other forms. Unsecured bonds are generally issued that are not backed by any asset class. This raises the question: why would an investor choose to invest in such a structure? When deciding whether to invest in a bond, the investor relies on creditworthiness, faith and credibility of the issuer.
Secured vs. unsecured bonds have one thing in common: the risk of repaying. Secured bonds are more secure than unsecured bonds, as their name implies to any investor. Secured bonds can be used to help bondholders recover their dues if an issuer fails to pay its principal amount or coupons. Investors consider secured bonds a good investment, even at low interest rates.
Unsecured bonds offer investors no security in the event that an issuer defaults or goes bankrupt. Unsecured bonds are chosen by investors based on their creditworthiness. While collateral can provide security, the main purpose of an issuer is not to default on regular bondholder dues.
The decision about whether to invest in a secured or unsecured bond should be made based on your financial goals. Although junk bonds are considered riskier investments, they can provide substantial returns if invested with a trusted issuer. Before investing in any bond, you should estimate your investment horizon and create a risk profile.