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Secured and Unsecured Bonds: Understanding Their Differences and Investment Implications

Abanti Chattopadhyay

5 min Read

27 Dec 2020

basics

bonds

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investment

Introduction

Bonds are a key investment option in fixed-income securities, offering investors stable returns and lower risk compared to stocks. However, not all bonds carry the same level of security. Based on collateral backing, bonds are classified into secured bonds and unsecured bonds.

Secured bonds are backed by specific assets, meaning the bondholders have a legal claim on these assets in case of default.
Unsecured bonds, also known as debentures, are not backed by collateral but rely on the issuer’s creditworthiness and reputation.
Investors must understand the differences between these two types of bonds to make informed investment decisions based on risk tolerance, return expectations, and financial security.

This article explores secured and unsecured bonds, their features, benefits, risks, and how investors can choose between them in Indian markets.

What Are Secured Bonds?

A secured bond is a bond that is backed by specific collateral, such as real estate, machinery, or other assets. If the issuer defaults, the bondholders can claim these assets to recover their investment.

Key Features of Secured Bonds

Backed by tangible assets or revenue streams (such as real estate, company equipment, or cash flow from specific projects).
Lower risk compared to unsecured bonds because investors have a legal claim on collateral.
Lower interest rates due to reduced risk for investors.

Examples of Secured Bonds in India

Government-backed bonds (e.g., Infrastructure bonds with land or assets as collateral).
Mortgage-backed securities (MBS) issued by housing finance companies.
Asset-backed bonds issued by corporates against tangible assets.

For example, a company may issue secured bonds using its manufacturing plant as collateral. If the company defaults, bondholders have the right to sell the plant and recover their funds.

What Are Unsecured Bonds?

An unsecured bond (also called a debenture) is a bond not backed by any specific collateral. Instead, investors rely on the issuer’s creditworthiness and ability to repay the debt.

Key Features of Unsecured Bonds

No asset backing, meaning higher risk for investors.
Issued based on the issuer’s financial strength and market reputation.
Higher interest rates compared to secured bonds due to increased risk.

Examples of Unsecured Bonds in India

Corporate debentures issued by companies with strong financial backing (e.g., Tata, Reliance, Infosys).
Public sector undertakings (PSU) bonds backed by the government’s creditworthiness.
Perpetual bonds issued by banks that do not have specific asset backing.
For example, a private company may issue unsecured bonds based solely on its credit rating and repayment ability. If the company defaults, bondholders have no collateral to recover their funds.

Key Differences Between Secured and Unsecured Bonds

1. Risk Level

Secured bonds are lower risk because they have collateral backing.
Unsecured bonds are higher risk because they depend solely on the issuer’s financial stability.

2. Interest Rates

Secured bonds offer lower interest rates due to reduced risk.
Unsecured bonds offer higher interest rates to compensate for added risk.

3. Repayment in Case of Default

Secured bondholders get priority repayment through asset liquidation.
Unsecured bondholders are repaid only after secured bondholders, increasing default risk.

4. Issuers of Bonds

Secured bonds are usually issued by infrastructure companies, real estate firms, and NBFCs.
Unsecured bonds are issued by corporates, financial institutions, and banks based on their creditworthiness.
For example, government-backed bonds are typically secured, whereas bank perpetual bonds are unsecured.

Advantages and Disadvantages of Secured Bonds

Advantages

Lower risk as they are backed by tangible assets.
Stable interest payments even in economic downturns.
Priority repayment in case of issuer default.

Disadvantages

Lower returns due to lower risk.
Limited availability as secured bonds are issued for specific projects.
Collateral dependency – If asset values fall, bondholders may recover less in case of default.

Advantages and Disadvantages of Unsecured Bonds

Advantages

Higher interest rates for better returns.
Easier to buy and trade compared to secured bonds.
More variety available from corporate and government issuers.

Disadvantages

Higher risk as there is no collateral.
No guaranteed recovery if the issuer defaults.
Market volatility affects bond prices more than secured bonds.
For example, during financial crises, corporate unsecured bonds face higher default risks compared to secured bonds.

Which Bond Should Investors Choose?

Choose Secured Bonds If:

You want low-risk investments with stable returns.
You prefer capital protection over high yields.
You want government-backed or asset-backed securities.

Choose Unsecured Bonds If:

You seek higher returns and can tolerate risk.
You trust the issuer’s financial strength and credit rating.
You are investing in strong corporate or government bonds with proven repayment history.
For example, an investor seeking stable, safe returns may choose secured infrastructure bonds, while a risk-tolerant investor may invest in high-yield corporate debentures.

How to Invest in Secured and Unsecured Bonds in India?

1. Government and Corporate Bonds via Exchanges

Bonds are listed on NSE (National Stock Exchange) and BSE (Bombay Stock Exchange).
Investors can buy secured and unsecured bonds through trading accounts.

2. Bond Mutual Funds and ETFs

Mutual funds invest in secured government bonds and unsecured corporate bonds.
Exchange-Traded Funds (ETFs) offer diversified exposure to bond markets.

3. RBI Retail Direct Platform

Investors can buy government-backed secured bonds directly from the Reserve Bank of India (RBI).

4. Private Placement and NBFC Bonds

Companies and financial institutions issue secured and unsecured bonds via private placement.
NBFC bonds offer higher returns but carry default risks.
For example, investors looking for tax-free interest may invest in tax-free PSU bonds.

Conclusion

Both secured and unsecured bonds serve different investment needs. Secured bonds offer low risk, stable returns, and asset-backed security, making them ideal for conservative investors. Unsecured bonds, on the other hand, provide higher returns with greater risk, making them suitable for investors willing to take credit risk for better yields.

Investors should evaluate credit ratings, issuer reputation, interest rates, and market conditions before choosing between secured and unsecured bonds. By balancing both types in a portfolio, investors can optimize risk and return while ensuring financial security.

References used:

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