What is the risk associated with bonds that are not secured by collateral?

Bonds that are not secured by collateral are often referred to as unsecured bonds or debentures. The primary risk associated with these types of bonds is credit risk, which is the risk that the issuer may default on their obligations, failing to pay interest or principal repayment as promised. Since these bonds are not backed by specific assets, investors have no claim on any collateral in the event of default, making the investment riskier in comparison to secured bonds, which are backed by specific assets like property or equipment.

Investors in unsecured bonds must rely on the creditworthiness of the issuer. If the issuer encounters financial difficulties, the lack of collateral means that investors may receive little or nothing in terms of repayment. Consequently, a thorough assessment of the issuer's credit rating and financial stability is vital for potential investors in unsecured bonds. This credit risk is a fundamental consideration when evaluating investments in bonds that lack collateral backing.