What is a Secured Bond?

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Types of Secured Bond

#1 – Mortgage Bonds

Mortgage bondsMortgage BondsA mortgage bond refers to a debt instrument backed by mortgaged assets such as equipment or real estate such as property, building, etc. It is a secured bond since the bondholders can recover their funds by selling the underlying collateral.read more are typically backed by real estate holdings or tangible property such as equipment. In case of default, the mortgage bondholders can sell off the underlying pledged property and get compensated for the invested amount—the ownership of the asset shifts to bondholders in case of default. As mortgage bonds are safer than corporate bondsCorporate BondsCorporate Bonds are fixed-income securities issued by companies that promise periodic fixed payments. These fixed payments are broken down into two parts: the coupon and the notional or face value.read more (no collateral), they have a lower rate of returnRate Of ReturnRate of Return (ROR) refers to the expected return on investment (gain or loss) & it is expressed as a percentage. You can calculate this by, ROR = {(Current Investment Value – Original Investment Value)/Original Investment Value} * 100read more.

#2 – Equipment Trust Certificate (ETC)

ETC refers to debt instrumentsDebt InstrumentsDebt instruments provide finance for the company’s growth, investments, and future planning and agree to repay the same within the stipulated time. Long-term instruments include debentures, bonds, GDRs from foreign investors. Short-term instruments include working capital loans, short-term loans.read more that allow the issuing company to take possession and use the asset while paying the bondholders over the period of time. The ownership of the asset is, without a doubt, belonging to the bondholdersBondholdersA bondholder is an investor who buys or holds a government or corporate bond.read more, but the company can use and generate income out of it. Investors supply capital by buying certificates; in turn, helping firms buy assets and lease it to them for operations if the borrower can meet lenders’ payment requirements, the ownership is transferred to the borrower. In case of default, the lenders get to choose what needs to be done with the assets.

Firms need not pay property tax on an asset as they have just leased the same from investors and thus increase their profitabilityProfitabilityProfitability refers to a company’s ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company’s performance.read more from operations. These types of debentures are usually seen in the airline and shipping industry (also with railway cars).

#3 – Secured Bonds by Municipalities

Municipalities can raise funds from investors through the issue of these types of secured bonds for a specific project. The bonds are backed by the anticipated revenue from that particular project. Upon disclosing the project’s details and anticipated revenue from the same, municipal bodies put forward the repayment strategy or plan to the investors. Depending on the trust of investors in the projects, they can buy these types of bonds.

Advantages

  • The limited or negligible risk for the principal repayment: As a collateralized asset backs the bonds, the bondholder’s principle can be repaid in case of default by selling an asset.Firms can avail tax benefits during purchase and evade property tax on assets leased in case of ETC deals.An investor gets to show bonds as long term investments and gets tax shields significantly on their regular income.Coupon payments or interest payments will generate cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more (yearly/quarterly/monthly) for the investor.Buying secured bonds backed by revenue streams will generate cash flow for investors upon the efficient execution of projects.Investors can pledge the bonds to raise money for banks or trade bonds in markets and benefit from trades.Firms can use secured bonds to raise extra capital in case if need be.Firms can lower the monthly repayment overheads by spreading them for a longer period of time.Convertible bondsConvertible BondsConvertible debt is a type of debt instrument that can be converted at the company’s discretion into equity shares. It is a hybrid security since it combines debt and equity features and provides additional benefits to the holder.read more give investors the right to convert to equity and reap profits out of it.

Disadvantages

  • If the market interest rate raises than the bond rate, the investor experiences losses as his coupon payment will be lesser than market payment (in case of fixed interest rate).When the interest rate rises in the market, the bond value goes down, and if the investor wants to liquidate the bond will get paid less than the market.If the market value of the collateralizedCollateralizedCollateralization is derived from the term “collateral,” which refers to a security deposit made by a borrower against a loan as a guarantee to recover the loan amount if s/he fails to pay.read more asset depreciates, the principal amount repayment gets affected in case of default.In a rising economy, the bond rate will get affected unless the coupon rate is pegged to the market rate.In case of an economic recessionEconomic RecessionEconomic recession is defined as the phase in which economic activities of a country become stagnant, leading to a disturbance in the business cycle and affecting the overall demand-supply balance. read more, when the market value of an asset depletes, the investor’s principal is stuck or only less than the usual amount can be retrieved.The interest rate on secured bonds is costly from a firm perspective in terms of a mortgage.

This has been a guide to what is a secured bond and its definition. Here we discuss its types along with the examples, advantages, and disadvantages. You can learn more about investment banking from the following articles –

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