What is a Guaranteed Bond?
How Does a Guaranteed Bond Work?
An entity that issues a guaranteed bond has solicited a third party (usually a bank, insurance company or another corporation) that agrees to pay the interest and principal payments on the bond should they, the issuer, be unable to make such payments. In exchange for guaranteeing the bond, the third-party guarantor receives a fee.
To illustrate, suppose City XYZ issues guaranteed municipal bonds. Company ABC guarantees the bonds in exchange for a $100,000 fee. If City XYZ is ever unable to make principal and interest payments to the bond holders, Company ABC will be responsible for making the payments.
Why Does a Guaranteed Bond Matter?
Guaranteed bonds are mutually beneficial to the issuers and the guarantors. 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.
During the recent financial crisis, the U.S. government guaranteed many different types of debt in order to get credit flowing again.