1.0IntroductionBondsA bond can be defined as a debt security in the market similar to other securities like I. O.U and other securities. Whenever investors purchase a bond, it lends money to the government, a corporation, a municipal or federal agency that is well known to the issuer. Bonds that are issued by corporations are taxable while once which federal government or municipal issues are exempted from tax (Kidwel and Johns 2010). A bond consists of the following components; BondholderPrincipal amountInterest rate that is paid to the issuer annuallyDate of maturitySharesShares are type of equity security.
The owner of the share owns one part of the capital of the company that has issued him or her with the shares. The shares gives shareholders the right to take part in the decision making process of the company and it depends on the type of shares one owns in the company (Kidwel and Johns 2010). If the company earns profit, the shareholders will earn dividend depending on the amount of dividends declared by the company directors. 2.0Types of BondsBonds can be classified in different ways they include; Government bonds: The government to raise more money to finance its projects using fixed security incomes.
They include Notes, bills and treasury bills. Municipal bonds: are issued by municipals to raise more funds internally to fund their project. They are more secured compared to corporates bonds but less lucrative compared to government bonds. They take long before they mature. Corporate bonds: These are bonds issued by companies in the same manner they issue shares. The corporate bonds are maturing faster compared with both the municipal and government bonds. Corporate bonds are subjected to tax whereas municipal and government bonds are not.
They are less secured compared with municipal and government bonds (Kidwel and Johns 2010). Another classification of bonds is covered and unsecured bonds. Covered bond are secured debt instruments and are normally issued by credit institution either as part of a single issuance and sometimes as a program by the financial institutions (ECB, 2008). Unsecured bonds are issued by corporates and are exposed to other economic changes like tax and inflation. Covered bonds are low risk interest bearing products with high maturity rate of more than one year and less than 30 years while secured bonds are less secured and mature faster compared with covered bonds.
Covered bond are also defined as one, which is backed with a pool of high quality security assets coming from the issuing banks (ECB, 2008). The covered pool consists mostly of relatively low risk assets and includes residential mortgages and public debts while unsecured bond consist of high-risk assets. The law requires the issuance bank to retain at least equal amount of the outstanding value of the covered bond.
Therefore, it adds to the number of assets to the covered pool in order to compensate for any decline in the quality of assets, which are in the pool. The assets in the pool are segregated from the bank other assets so that covered bond investors are in a position to enforce their security interest over those assets in the events that the banks default (Reserve Bank of Australia, 2013). The recourse of the covered bondholder in this pool is the major distinction between unsecured bond and covered bond.
In the event of a default, the holders of the bond have the preferential recourse to a specific asset that is known as the cover pool. The multiple recourse nature of the covered bonds normally seeks to ensure that the bonds withstand any distress that is experienced by the issuer, or that is caused by any underlying collateral. If unsecured bonds and other securities compare the covered bond, the covered bond is more superior to any other market securities (Reserve Bank of Australia, 2013). Covered bond has dual-recourse bonds with a claim on the issuer and covered pool of high quality collateral that, throughout the bond term, dynamics is required by the bond issuer.
In order to maintain the quality if the specified assets, the issuer pool must be reignited by issuing new assets.