Before we understand what is the benefit of investing in secured bonds, let’s take a quick minute to understand what are bonds / debt instruments.
When a company wants to raise capital to expand its business, it has majorly two options:
- Provide ownership in the company in exchange of money
- Take loan from the market
When the company takes loans as a means to raise capital from the market, it issues bonds in return.
Bonds are nothing but debt instruments where the investor is providing a loan to the company in exchange of a fixed interest rate.
Bonds issued by companies are called corporate bonds. While, the bonds issued by Government are called Government Bonds.
What are secured Bonds
Basically, there are two types of bonds, secured bonds and unsecured bonds. A secured bond is a type of bond that is backed by a security like tangible asset.
This means that the company provides a collateral against the capital it wishes to raise from the market in the form of debt. It is a type of loan that is backed by a security of equivalent oh higher value.
Benefit of investing in secured bonds
Here are 4 benefit of investing in secured bonds:
Backed by tangible assets
As explained in the preceding paragraph, secured bonds are backed by tangible assets. These assets could be company’s office, manufacturing facility or other tangible assets that can be sold off to pay the debt.
As the capital raised by secured bonds have real assets backed which can be liquidated in case of default, there have much lower exposure to risk.
Investors need not worry about the company’s future performance, as even in the worst case scenario, if the company defaults its loan, the assets will be sold off and the principal capital will be returned to the investors.
Thus, the principle investment of the investors stay protected.
Provide a fixed source of income
Bonds and debt instruments have a fixed rate of return. This rate of return is independent of the market performance. The bonds are issued and the investor invests in them as a loan to the company.
As the investors are lending money, they are promised with a fixed rate of return. For secured bonds the rate of return can be in a range of 7 – 10% per annum, depending on the company’s overall performance and credit rating.
These interest payouts can be monthly, quarterly, semi-annually or annually depending on the obligation of the company at the time of issuing bonds.
Thus, there is a stable return generated by the investors, without testing the timing of the market and its performance.
Does not carry market risk
Investment made in stocks are subject to market risk. When the economy goes down, so will the prices of the shares. The investment of the investors are exposed to external factors that will determine the returns gained.
On the other hand, bonds do not carry any market risk. They are risk independent irrespective of the company’s performance during the tenure.
The company is obliged to provide interest on the collected capital irrespective of its performance in its tenure.
The bonds issued by the companies are traded on the stock exchange, making it easier for the investors to enter and exit these debt investments.
As the bond are secured by tangible assets, it makes it more appealing to investors to trade the same in the secondary markets as well.
Due to the high demand for secured bonds, there is high liquidity in the markets for buying and selling.
You might also like: 5 Reasons Why Bonds Are Better Investment Than Debentures
It is to be noted that, secured bonds are comparatively carry lesser risk than unsecured bonds. Due to this minimal risk exposure it possesses, the interest rate on these bonds are on the lower side.
Whereas an unsecured bonds can fetch a return of 12 – 15%, a secured bond will yield a return of about 7 – 10%. But in case of protection of principal, secured bonds are more dependable.
One needs to take a thorough view before investing in bonds, rather than only getting attracted towards higher interest rates.
Also Read: How Do Mortgage Backed Securities Make Money