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What is a Guarantee Bond?

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  • Last Modified Date: 28 August 2016
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Also known as a financial guarantee bond, the guarantee bond is a bond issue that is configured to pay a minimum amount of return, regardless of the performance of the principal. While investors do have this commitment to receive something back from the investment, the minimum is normally well below the return that would be generated if the principal did perform according to expectations. Looking closely at the bond structure and the underwriting fund for the bond is important, since these types of bonds may be underwritten.

A guarantee bond looks very much like any other bond issue, in that the investor is anticipated to earn something above and beyond the original investment. What is different is the guarantee affirms there will be some amount of return, even if the project that the bond is funding does not come to fruition. This type of guarantee can be very comforting to investors who are conservative with their investment activities, since even in the worst case scenario, they will earn at least a small return.

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There are several different types of bonds that may be written as guarantee bonds. It is not unusual for tax bonds to be written in this manner. In some cases, bonds that have to do with government operated healthcare programs may utilize the guarantee bond strategy when creating bond issues. In some areas of the globe, municipalities may also issue guarantee bonds as a means of generating revenue for building construction, street improvements or any other type of similar community improvement project.

While there are many examples of guarantee bonds that do have an equitable amount of underwriting, others are purposefully underwritten. When this is the case, the potential for the guarantee bond to perform to expectations is somewhat minimized. It is still possible for the investor to earn the anticipated return, but it is much more likely that what he or she will ultimately receive is a figure closer to that guaranteed minimum return.

When considering the purchase of a guarantee bond, savvy investors will play close attention to the amount of guaranteed return, and determine if that amount is sufficient to warrant the purchase. At the same time, verifying the underwriting is also a good idea. Doing so helps to set reasonable expectations on the part of the investor, and make it much easier to determine if the investment is worth the time and money invested, or if the investor should look for a different investment opportunity

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David09
Post 4

@Mammmood - I think the bottom line is that all investments carry risk. I think before you buy bonds or stocks or whatever, you should consult with a money saving expert (otherwise known as a financial consultant) who will help you make the best decision, given your current circumstances.

Mammmood
Post 3

@NathanG - That’s true, but municipal bonds can carry the risk of default as well.

These are backed by local governments, and if the bonds are issued for things like convention centers or recreational facilities – things which in the end may not draw enough business depending on the state of the company – even municipal bonds can go into default.

It’s not common, but states and cities can go bankrupt just like businesses can. However, municipal bonds usually give a fair rate of return from what I’ve heard.

I’ve never purchased them myself, but I hear the average is about 6-7% or something like that. That’s not bad, and is comparable to annualized stock market returns.

NathanG
Post 2

@hamje32 - I agree with your overall financial advice, however one point needs clarification. Not all bonds are government bonds and therefore guaranteed, at least in the sense that you describe.

For example, you can also buy corporate bonds. These are bonds that corporations issue so that they can raise money needed to help expand their business. These bonds have shorter time frames for maturity.

However, they come with risk, more risk than you would get with a government bond. That risk of course is that the company can go belly up, and the corporate bonds would be junk.

I know from experience, because I bought a bunch of corporate bonds a long time ago from a large company and they eventually filed for bankruptcy. My bonds were worthless paper. So yes, bonds generally are safe, but not always, depending on the type you buy.

hamje32
Post 1

As an investor, I like anything that comes with the word “guarantee,” but there is also a tradeoff.

More security means less return on your investment. Higher risk and less security mean the potential – though certainly not the guarantee – of a higher rate of return on your investment.

That’s the why the best financial strategy involves having a mix of assets, like stocks and bonds. Generally, if stocks go down the bond market goes up. That’s because everyone is fleeing stocks to buy bonds, which provide a safe haven.

Government guaranteed bonds are the safest bet, since they’re backed by the full faith and credit of the United States government.

I always make it a point to diversify my portfolio. Right now, in my earning years, I’ve got mostly stocks, with some bonds and even a little bit of gold. When I near retirement, I will flip to mostly bonds, and less investment in stocks.

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