Unsecured bond definition
/What is an Unsecured Bond?
An unsecured bond is an obligation of an organization or government that is not backed by any assets. An unsecured bond is also not backed by the stream of cash flows from any revenue-generating operations. Instead, investors are relying upon the general creditworthiness of the issuer in deciding whether to purchase such a bond.
The Riskiness of Unsecured Bonds
If the interest on an unsecured bond or the bond itself is not paid by the issuer, purchasers of the bonds are clustered with general creditors in making claims for repayment. This can mean that investors will be paid substantially less than the amount they originally invested in the bonds, and at a much later date than expected. Given this extra risk, the interest rate that investors demand on unsecured bonds tends to be higher than the rate for secured bonds.
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Examples of Unsecured Bonds
Here are several examples of entities that may issue unsecured bonds:
No assets available. A corporate or government entity may sell unsecured bonds because it does not have a sufficient amount of assets to serve as collateral for the bonds. In this case, it will likely have to pay an unusually high interest rate in order to attract investors.
Highly-rated issuer. An issuer may be so large, profitable, and well-financed that investors are willing to do without the extra protection of a security feature.
Government issuer. A government may simply raise taxes if it needs additional funds to pay off its bond obligations, and so sees no need to issue secured bonds.
How to Protect Yourself When Investing in Unsecured Bonds
To protect yourself when investing in unsecured bonds, evaluate the issuer’s credit rating through agencies like Moody’s or S&P—higher ratings indicate lower default risk. Diversify your portfolio to spread exposure across different issuers and industries. Review the bond's prospectus to understand its terms, including interest rate, maturity, and covenants. Pay close attention to financial statements and performance metrics of the issuing company. Consider investing through bond funds managed by professionals if you are unfamiliar with bond markets. Be wary of unusually high yields, which often signal increased risk. Lastly, stay updated on market conditions and the issuer’s financial health, and consider working with a financial advisor for tailored guidance. Caution and due diligence are key when investing in unsecured debt instruments.
Terms Similar to Unsecured Bond
An unsecured bond is also called a debenture.