Bonds offer some protection against the volatility and risk of stocks. Unlike stocks, investing in a bond makes you a creditor of the bond issuer, and you’ll have a high ranking claim on assets if the issuer defaults on the bond’s payment terms. Bonds fall under two categories: secured and unsecured. A mortgage bond is a type of secured bond; a debenture bond is also referred to as an unsecured bond.
Characteristics of a Mortgage Bond
A mortgage bond is a type of secured bond because the bond is backed by collateral. The collateral is usually real estate or some other type of property that is subject to a mortgage. In the event of a bond default, you can foreclose and sell the property tied to the bond to collect your investment. Due to their direct claim on company assets, a mortgage bond is a safer and higher quality investment with a lower risk of default than a debenture bond.
Example of a Mortgage Bond
An example of a mortgage bond is a commercial mortgage bond. These bonds are tied to loans for commercial property that can range from a major hotel to a mall in a small town. According to Bloomberg, commercial mortgage bond sales reached a high of $232 billion in 2007. In 2008, as the financial crisis affected lending and credit markets, sales dropped to $12.2 billion. In 2012, several investment banks are preparing offerings of commercial mortgage bonds; finalizing payment terms has been difficult due to Europe’s ongoing debt crisis, which affects bond prices and interest rates.
Characteristics of a Debenture Bond
A debenture, or unsecured, bond is not backed by property. The bond issuer’s credit standing supports the promise that the bond’s payment terms will be met. Debenture bonds are issued when a company does not have enough assets to serve as collateral. If a company is well established and has a high credit rating, issuing debenture bonds is an easy way for them to raise funds. Debenture bonds typically carry more risk than mortgage bonds and must pay a higher interest rate to investors. If a company liquidates, debenture bondholders are paid after mortgage bondholders.
Example of a Debenture Bond
An example of a debenture bond is the U.S. government’s Treasury bond. These bonds are guaranteed by the full faith and credit of the U.S. government and are available in a variety of maturity periods, ranging from one month to 30 years. Unlike debenture bonds issued by private businesses, this type of debenture bond is not considered high risk due to the federal government's ability to create money, if it needs to, to meet payment terms.
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