Corporate bonds are debt securities issued by private and public corporations. These bonds are issued to meet specific requirements like building a new plant, purchasing machinery or to meet expansion activities.
Corporate bonds can be classified as - Secured Debt, Unsecured Debt, and Credit Enhancements.
Along the dimension of security, bonds can be classified into unsecured (straight) bonds and secured (mortgage) bonds. Unsecured bonds have no charge on any specific assets of the company while secured bonds carry a fixed or floating charge on the assets of the company.
The distinction between secured and unsecured bonds becomes relevant in case the issuer defaults in the payment of interest or principal. The secured bondholders are entitled to take possession of the security given to them and realize their dues by selling these assets (typically land, building, machinery, etc.). This right is valuable to the bondholders provided the security is valuable, easily saleable and has not been simultaneously given as security to other creditors. All these factors have to be examined while evaluating a secured bond. Unsecured bonds are not backed by any such security, but the bondholder does not need to worry about this if he believes that the company is financially very sound and is unlikely to default.
In order to enhance the creditworthiness of the issuing company, some debt issuers have other companies guarantee their loans. This enhancing feature is usually seen when a subsidiary issues debt and the investors want the added protection of a third-party guarantee. This sort of guarantee is useful and convenient to finance special projects and affiliates. However, these guarantees may also be extended to the operating company debts.
Another credit enhancing feature is the Letter of Credit (LOC). The bank issues LoC. Here, the bank makes the payments to the trustee when required so that funds will be available for the issuer to meet its payment obligations. Therefore, we see that the credit of the bank is substituted for the credit of the issuer.