Guaranteed Bonds

A guaranteed bond is a bond that is guaranteed by another entity (usually a bank, a subsidiary company, 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.

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 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.

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.

• One tranche has only fixed-rate bonds with an interest rate of 6%. The maturities for these bonds range from 10 – 15 years.
• One tranche has only floating rate bonds with interest rates linked to the Libor rate. The maturities for these bonds range the same as above, i.e., 10 – 15 years.
• The final tranche has only fixed-rate bonds with a guarantee by the government. These bonds bear an interest rate of 3.5 % – 4%, and the maturities for these range from 5 – 15 years.

Usually, municipal bonds 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.  

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

• Guaranteed bonds have additional security for the investor’s invested money since it is not only assured by the issuer of the bond but also guaranteed by the guarantor.
• It benefits not only the bond issuer but also the bond guarantor since the issuer gets to borrow at a lower interest rate, and the guarantor receives the fee or premium for imbibing the risk of guaranteeing the debt of another entity.
• Guaranteed bonds are most sought after by investors who wish to invest in securities with low risk for the long term. The investment pays at regular intervals, and the risk of default is very minimal.
• In the United Kingdom, a guaranteed bond refers to the fixed-rate bonds, which mean the fixed interest on the bond is guaranteed, whereas, in the United States, a guaranteed bond refers to the guarantee by a third party on the interest payments and the principal amount itself.
• Even the most secure bonds issued by a company with a weak financial history can find it difficult to sell the bonds without a third-party guarantee.

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 bondholder 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.

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

• As the risk is low, the return on investment is low, which means the interest payments are relatively low when compared to bonds that are not guaranteed.
• From the bond issuer’s point of view, having a guarantor increases the cost of procuring the capital, which in other cases, can be either issued without guarantee. In either case, the cost gets offset since a bond with no guarantee bears a higher interest, whereas a guaranteed bond bears a lower interest but with the cost of the premium that is paid to the guarantor.
• It involves many procedures to obtain a guarantee since the guarantor would conduct a thorough check on the issuer’s creditworthiness and financial stability. For a regular bond, the issuer can get away with this hassle of additional documentation.
• The bond issuer has to provide information regarding its financials not only to the investors but also to the guarantors, which can impact the image of the issuer in case the financials are not in good shape.

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 –

• Bearer Bond Example
• Baby Bonds
• Surety Bond
• Coupon Bond Definition