
Guaranteed Bond
A guaranteed bond is a debt security that offers a secondary guarantee that interest and principal payments will be made by a third party, should the issuer default due to reasons such as insolvency or bankruptcy. To mitigate any default risk and provide credit enhancement to its bonds, an issuing entity may seek out an additional guarantee for the bond it plans to issue, thereby, creating a guaranteed bond. A guaranteed bond is a debt security that offers a secondary guarantee that interest and principal payments will be made by a third party, should the issuer default due to reasons such as insolvency or bankruptcy. On the downside: Because of their lowered risk, guaranteed bonds generally pay a lower interest rate than an uninsured bond or bond without a guarantee. On the downside, guaranteed bonds tend to pay less interest than their non-guaranteed counterparts; they also are more time-consuming and expensive for the issuer, who has to pay the guarantor a fee and often submit to a financial audit.

What Is a Guaranteed Bond?
A guaranteed bond is a debt security that offers a secondary guarantee that interest and principal payments will be made by a third party, should the issuer default due to reasons such as insolvency or bankruptcy. A guaranteed bond can be of either the municipal or corporate variety. It can be backed by a bond insurance company, a fund or group entity, a government authority, or the corporate parents of subsidiaries or joint ventures that are issuing bonds.




How a Guaranteed Bond Works
Corporate and municipal bonds are financial instruments used by companies or government agencies to raise funds. In effect, they are loans: The issuing entity is borrowing money from investors who buy the bonds. This loan lasts for a certain period of time — however long the bond term is — after which the bondholders are repaid their principal (that is, the amount they . originally invested). During the life of the bond the issuing entity makes periodic interest payments, known as coupons, to bondholders as a return on their investment.
Many investors purchase bonds for their portfolios due to the interest income that is expected every year.
However, bonds have an inherent risk of default, as the issuing corporation or municipality may have insufficient cash flow to fulfill its interest and principal payment obligations. This means that a bondholder loses out on periodic interest payments, and — in the worst-case scenario of the issuer defaulting — may never get their principal back, either.
To mitigate any default risk and provide credit enhancement to its bonds, an issuing entity may seek out an additional guarantee for the bond it plans to issue, thereby, creating a guaranteed bond. A guaranteed bond is a bond that has its timely interest and principal payments backed by a third party, such as a bank or insurance company. The guarantee on the bond removes default risk by creating a back-up payer in the event that the issuer is unable to fulfill its obligation. In a situation whereby the issuer cannot make good on its interest payments and/or principal repayments, the guarantor would step in and make the necessary payments in a timely manner.
The issuer pays the guarantor a premium for its protection, usually ranging from 1% to 5% of the total issue.
Advantages and Disadvantages of Guaranteed Bonds
Guaranteed bonds are considered very safe investments, as bond investors enjoy the security of not only the issuer but also of the backing company. In addition, these types of bonds are mutually beneficial to the issuers and the guarantors. Guaranteed bonds enable entities with poor creditworthiness to issue debt when they otherwise might not be able to do so, and for better terms. Issuers can often get a lower interest rate on debt if there is a third-party guarantor, and the third-party guarantor receives a fee for incurring the risk that comes with guaranteeing another entity's debt.
On the downside: Because of their lowered risk, guaranteed bonds generally pay a lower interest rate than an uninsured bond or bond without a guarantee. This lower rate also reflects the premium the issuer has to pay the guarantor. Securing an outside party's backing definitely increases the cost of procuring capital for the issuing entity. It can also lengthen and complicate the whole issuing process, as the guarantor naturally conducts due diligence on the issuer, checking its financials and creditworthiness.
Related terms:
Busted Bond
A busted bond is one where an issuer has failed to pay required interest payments and/or principal amounts to the debt holder. read more
Collateral Trust Bond
A collateral trust bond is a bond that is secured by a financial asset, like a stock, that is deposited and held by a trustee for the bondholder. read more
Coupon
A coupon is the annual interest rate paid on a bond, expressed as a percentage of the face value, also referred to as the "coupon rate." read more
Debenture
A debenture is a type of debt issued by governments and corporations that lacks collateral and is therefore dependent on the creditworthiness and reputation of the issuer. read more
Financial Guarantee
A financial guarantee is a non-cancellable promise backed by a third party to guarantee investors that principal and interest payments will be made. read more
Fixed Income & Examples
Fixed income refers to assets and securities that bear fixed cash flows for investors, such as fixed rate interest or dividends. read more
Guarantor
A guarantor is a person who guarantees to pay a borrower's debt if they default on a loan obligation. Read more about the role of a guarantor in finance. read more
Municipal Bond
A municipal bond is a debt security issued by a state, municipality or county to finance its capital expenditures. read more
Variable-Rate Demand Bond
A variable-rate demand bond is a municipal bond with floating coupon payments that are adjusted at specific intervals. read more