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 bondsguaranteed 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 