An unsecured bond is an obligation of an organization or government that is not backed by any assets. An unsecured bond is also not backed by the stream of cash flows from any revenue-generating operations. Instead, investors are relying upon the general creditworthiness of the issuer in deciding whether to purchase such a bond. If the interest on an unsecured bond or the bond itself is not paid by the issuer, purchasers of the bonds are clustered with general creditors in making claims for repayment. This can mean that investors will be paid substantially less than the amount they originally invested in the bonds, and at a much later date than expected. Given this extra risk, the interest rate that investors demand on unsecured bonds tends to be higher than the rate for secured bonds.
A corporate or government entity may sell unsecured bonds for any of the following reasons:
- It does not have a sufficient amount of assets to serve as collateral for the bonds.
- The entity is so large, profitable, and well-financed that investors are willing to do without the extra protection of a security feature.
- A government can simply raise taxes if it needs additional funds to pay off its bond obligations.
An unsecured bond is also called a debenture.