Guaranteed Bonds

Updated on April 3, 2024
Article byAbhilash Ramachandran
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Guaranteed Bond Meaning

A guaranteed bond is a bond that is guaranteed by another entity (usually a bank, a subsidiary companySubsidiary CompanyA subsidiary company is controlled by another company, better known as a parent or holding company. The control is exerted through ownership of more than 50% of the voting stock of the subsidiary. Subsidiaries are either set up or acquired by the controlling company.read more, or an insurance company) in case the issuer of the bond defaults to make the repayments as a result of business closure or insolvency. The entity that guarantees the bond is referred to as the Guarantor.

Guaranteed Bonds

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Guaranteed Bonds (wallstreetmojo.com)

The premium paid depends on the creditworthiness of the bond issues, and if the finances of the business are in good shape, the premium charged will be much less, ranging from 1 % to 5%. For instance, the premium charged for treasury guaranteed bonds will be the least as it is backed by the government and least likely to default.

Guaranteed Bonds Explained

Guaranteed bonds are often issued by governments or highly reputable entities, carry a promise of repayment of both the principal amount and interest, offering a higher level of security compared to other bond types.

The essence of guaranteed bonds lies in the financial commitment made by the issuer to honor their repayment obligations. The creditworthiness and stability of the issuing entity typically backs this commitment. Governments, for example, may issue guaranteed bonds as a means of raising capital for various projects, and the ‘guarantee’ implies a commitment to repay the borrowed funds.

Investors are drawn to them despite additional guaranteed bond rates for their predictable returns and reduced risk exposure. The assurance of receiving both principal and interest at the agreed-upon terms provides a level of stability that resonates with risk-averse investors. Additionally, the guarantee often translates to a higher credit rating for these bonds, making them an attractive option for those seeking a balance between security and returns.

However, it’s crucial for investors to carefully assess the credibility of the issuer and the terms of the guarantee before investing in guaranteed bonds. While they offer a reliable investment avenue, understanding the financial health of the issuer remains paramount to making informed investment decisions. In a landscape where stability is paramount, guaranteed bonds emerge as a steadfast choice for investors prioritizing security and consistent returns.

Fixed Income Course (5+ Hours Video Series)

–>> If you want to Master Fixed Income, then you can consider our course on “Fixed Income: Valuation, Return and Risk Measures” provides a comprehensive overview of bond valuation, return metrics, and risk management within fixed income securities. The learners will gain required skills for analyzing bond characteristics, calculating yield measures, and implementing risk mitigation strategies, equipping them for success in navigating the intricacies of bond markets.

Examples

Now that we understand the basics and intricacies of regular and treasury guaranteed bonds, let us apply that knowledge to practical application through the examples below.

Example #1

The state of Mississippi requires funds to create a cycling track and joggers’ park along with a community hall. The project has been approved by the officials and has been named ‘Mississippi Greens.’ Since this is a project for the welfare of the people, the officials have decided to procure funds by way of issuing bonds in the market.

The bonds will be issued in a series of bonds with maturities ranging from 5 to 15 years. They have decided to issue fixed interest rate bonds, fixed to floating interest rate bonds, floating interest rate bonds, and variable interest rate bonds. Since the officials want to borrow at the lowest possible rate, they are looking to issue a variety of bonds with different features.

Usually, municipal bonds Municipal BondsA municipal bond is a debt security issued by a national, state, or local authority to finance capital expenditures on public projects related to the development and maintenance of infrastructures such as roads, railways, schools, hospitals, and airports.read more do not bear an interest above 4% since these have the goodwill of the municipality or the state that issues these bonds. If these bonds have a guarantee backing the payments, then the risk is practically negated since the Government backs it.

Investors looking for a low-risk investment can invest in the final tranche with a guarantee since it is like a fixed deposit that will give returns at regular intervals.

Example #2

EU antitrust regulators fined Rabobank, the Dutch banking and financial services giant $29 million for taking part in a Euro-dominated bond cartel that lasted a decade from 2006-2016.

Cartels like these have been coming under the scanner from time to time for rigging key financial benchmarks and currencies. This cartel, in particular, was found to concentrate on Euro-dominated SSA bonds such as foreign sovereign, supra-sovereign, agency bonds, and government bonds traded in Europe.  

Importance

Let us understand the importance of investing in these bonds despite the additional guaranteed bond rates through the points below.

Advantages

Let us understand the advantages of treasury guaranteed bonds through the points below.

  • The investor can rest assured that his/her investment is in safe hands, and even in the worst scenario, the principal and the interest payments would be paid by a third party, which has guaranteed the payments.
  • Risk is lowered since the bondholderBondholderA bondholder is an investor who buys or holds a government or corporate bond.read more not only has the security of the issuer, making the payments but also the guarantor.
  • Guaranteed bonds enable investors with poor creditworthiness to issue a bond with a guarantee, thereby attracting investors to invest in the bonds that pay a lower interest rate, which otherwise would bear more interest without the guarantee.

Disadvantages

Despite the various advantages, there are a few factors that prove to be a disadvantage with regard to guaranteed bond rates through the points.

Guaranteed Bonds Vs Secured Bonds

Let us understand the difference between treasury guaranteed bonds and secured bonds through the comparison below.

Guaranteed Bonds

  • Guaranteed bonds involve a commitment from the issuer, often a government or highly reputable entity, to repay both the principal amount and interest.
  • The guarantee is based on the creditworthiness and financial stability of the issuer, providing investors with a higher level of confidence in the security of their investment.
  • Investors are assured of receiving both principal and interest at the agreed-upon terms, offering predictable returns and reducing the level of risk associated with the investment.
  • The guaranteed nature of these bonds makes them particularly attractive to risk-averse investors seeking a balance between security and returns.
  • Guaranteed bonds often receive higher credit ratings due to the assurance provided by the issuer, making them a preferred choice in the fixed-income investment landscape.

Secured Bonds

  • Secured bonds are backed by specific assets of the issuer, such as real estate or equipment, providing an added layer of security for bondholders.
  • In the event of default, bondholders have a claim on the specified assets, which serve as collateral. This collateral helps mitigate the risk associated with the investment.
  • Secured bonds can be issued by a range of entities, including corporations and governments, and the level of security depends on the type and value of the underlying collateral.
  • Investors in secured bonds benefit from a balance between risk and return. While not as risk-free as guaranteed bonds, the presence of collateral enhances the security of the investment.
  • Understanding the quality and liquidity of the underlying collateral is crucial for investors considering secured bonds, as it directly impacts the level of risk associated with the investment.

This has been a guide to Guaranteed Bonds and its meaning. Here, we explain its example, advantages, and disadvantages and compare it with secured bonds. You can learn more about financial bonds from the following articles –