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Bonds can either be secured by some sort of
collateral or unsecured. Unsecured bonds, called debentures, are considered
to be riskier than secured bonds because they are simply backed by the
issuer's word that it will repay the bonds. Secured bonds are backed by some
goods that can be sold by the issuer to raise money to pay off the debt in
the event of default. Corporate and municipal bonds can be secured or
unsecured, while bonds issued by the federal government are unsecured (but,
of course, the government can simply print money to pay off its debts).
The most common form of secured bonds are
mortgage bonds. These bonds are backed by real estate or physical equipment
that can be liquidated. These are thought to be high-grade, safe
investments. Other bonds are secured by the revenues created by projects. If
an issuer in default has both secured and unsecured bonds outstanding,
secured bondholders are paid off first, then unsecured bondholders.
Naturally, because unsecured bonds carry greater risk than secured bonds,
they usually pay higher yields.
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