What is a Covered Bond?

Covered bonds are bond issues that are created from various types of mortgages and other types of private sector loans. The bonds themselves are backed with loans that are not associated with the group used to create the securities. Bonds with this type of cover or backing are often considered excellent investment options, owing to the fact that a covered bond often yields a higher rate of return than other types of bonds.

There are a few basic characteristics that distinguish the covered bond from other bond types. One has to do with the duration. While there other bond issues that may mature within a year, the typical covered bond requires a minimum of two years. Some covered issues may take as long as ten years to reach full maturity. For this reason, the bond may be an ideal choice for a long-term investment that is considered stable and relatively impervious to changes in the economy.

Another characteristic that helps to set a covered bond apart from other bond issues is the yield associated with the bond. The combination of creating the bond using qualified mortgages, then covering or backing the bond with a different group of loans, helps to provide a high degree of stability to the investment. At the same time, the structure of the bond also provides a higher interest rate than many other types of bonds. This means that an investor who does tend to prefer investments that carry a low rate of volatility can stand to earn a higher return by choosing a covered bond over other types of bond issues.

While the origination of the covered bond is attributed to several countries that are part of the European Union, this type of investment opportunity can also be utilized in the United States, Canada, and several other countries around the world. Most nations have their own particular set of regulations regarding the issuance of covered bonds, as well as for buying and selling the bond issues. In some instances, there are limits imposed on the amount of covered bond issues that a particular investor can hold at any given point in time. This is often seen as a means of preventing the bond market from being controlled by a relatively small group of investors. Other countries place no limits on the number of covered securities of any type, including bonds that are covered, or the total face value of the bonds that are held by any one investor.