Bonds are debt instruments issued by government agencies or large corporations to raise capital funds. These bonds fall under two categories: secured and unsecured. A secured bond is where an asset class backs the instrument. The asset can be anything physical like machinery, plants or property. But it can also be liquid in the form of stock. On the other hand, unsecured bonds are those that are not backed by assets. Understand the difference between these bonds from the following section to determine the best choice.
Difference Between the Secured and Unsecured Bonds
The following are some of the significant differences between unsecured and secured bonds.
Collateral
Secured bonds are supported by collaterals that form a protective barrier in case of a default. The bondholder can seize and sell the collateral during a default to recover their investment. At the same time, unsecured bonds do not have collaterals and are based on the issuer’s creditworthiness. Investors only rely on the issuer’s financial performance and strength to meet the necessary payment obligations.
Interest Rates
Secured bonds provide low interest rates compared to unsecured bonds. It reduces your risk but also provides lower returns. On the other hand, unsecured bonds have high interest rates and high potential returns.
Risk Level
Secured bonds are considered less risky since they are backed by collateral, and they are great for conservative investors. On the other hand, unsecured bonds are very risky since no asset is involved. Investors depend entirely on the issuer’s repayment capacity in these bonds, and they are great for those who desire high returns at a high risk.
Recovery in Default
People with secured bonds are in a better situation during default since there is a legal claim to the collateral. Investors can sell that collateral to get their investment amount. However, no such protection exists in unsecured bonds. Since there is no collateral, investors do not have anything to fall back on during default. So, it complicates the repayment process.
Investor Profile
Generally, it’s the conservative investors or those looking for stability and safety in their portfolios who invest in secured bonds. In comparison, unsecured bonds are great for those who want to diversify their portfolio and boost their returns even at the cost of higher risk.
Credit Ratings
Secured bonds have additional protection due to the collateral backing them and do not need to depend on credit facilities. In contrast, unsecured bonds lack collateral, which makes them rely on credit ratings.
Example
Some of the common examples of secured bonds include asset-backed securities that are supported by credit card receivables or auto loans. Then, there are mortgage-backed securities, the collateral of which is real estate. Some of the examples of unsecured bonds involve government bonds that depend on the issuing government’s creditworthiness. Government bonds are typically unsecured, but there are exceptions like U.S. Treasury bonds, which are considered very secure due to government backing. Also, there are corporate bonds, where investors depend on the company’s creditworthiness and financial strength.
Wrapping Up!
The best investment is the one that suits your risk appetite and portfolio. However, getting a mixture of secured and unsecured bonds is also possible since that balances the risk and returns. The secured bonds provide reliability and stability to a portfolio. On the other hand, unsecured bonds offer increased potential returns.
FAQs
1. What is the purpose behind an unsecured bond?
An unsecured bond allows organisations to borrow some money without using any collateral. It is helpful for companies in need of funds, and it delivers high returns to investors.
2. What to do if there are defaults on a secured bond?
If an issuer defaults on a secured bond, then the investor can always sell the collateral to get the invested amount back. This ensures that you always get a return on your investment in one way or the other.
3. Are secured bonds entirely exempt from default risk?
Secured bonds have low default risk, but they are not exempt from it. As such, people always need to check the bond issuer’s financial stability before investing.
