Covered bond obligations are investment grade bonds backed by a pool of junk bonds, often corporate bonds, of varying credit quality. They offer stable backing and credible interest rates, making them an attractive option for smaller investors.
A covered bond obligation is a bond that is considered investment grade. The bond obligation is backed by the use of a pool of junk bonds, which are generally not considered investment grade. However, the combination of various junk bonds representing different types of credit quality is often considered sufficient to provide the covered bond obligation with investment grade bond status.
In most cases, the junk bonds used to back a covered bond obligation will be corporate bonds. The different tiers in the credit quality of the bond collection help provide overall stability to the backing, as there is a good chance that most, if not all, of the bonds will hold their value through the bond issuance. Due to the diversity of supporting instruments, a covered bond obligation can be an attractive option for an investor.
Commonly known as a CBO, the covered bond obligation is generally issued at credible interest rates, although the rates are not always the best in the market. Part of determining the interest rate that is spread has to do with the exact composition of the junk bonds that back the obligation. If most bonds tend to have healthy interest rates, the covered bond obligation will reflect those circumstances.
As with any type of bond issue, a covered bond obligation carries some element of risk. However, it should be noted that the risk is somewhat minimal when considered in light of the interest rate that is generally applicable. A covered bond obligation is not an investment that might attract investors who want to make large profits from the company, but smaller investors often find this type of bond obligation worth considering with its modest yield. Brokers dealing in bond issues can often direct clients to bond obligations of this type that offer excellent potential.
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