Collateralized Securities May Offer Lower Rates

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Collateralized Securities May Offer Lower Rates

Because adding collateral lowers a security’s risk, it can also affect its return. The more risk an investment has, the more investors expect to be compensated for taking that risk. The higher the quality of the collateral, the better its credit rating and the lower its return need be. Corporate bonds with collateral will generally have lower coupon rates than non-collateralized corporate bonds.

How government bonds work

Government bonds behave a little differently. The power of a federal or state government to raise revenue through taxation is perceived to be more secure than collateral. Therefore, unsecured government bonds may have higher ratings than collateralized government bonds. For example, municipal bonds not secured by collateral are secured by the government’s power to increase taxes and create the needed funds to pay off the bonds. Because government collateralized securities are not backed by the government’s taxation power, they have a higher risk than other government bonds and thus may have higher coupon rates.