A type of fixed-income security that provides investors with a higher level of protection compared to uncovered debt securities/ unsecured debt securities. Such a security is backed by certain assets or collateral that serve as a guarantee for the investors (holders). By having collateral tied to the instrument, the issuer limits the potential losses that investors may face in case of default. Specifically, in the event of default, the collateral (collateralized assets) can be seized and liquidated to repay the investors.
Unlike uncovered debt securities, which depend entirely on the issuer’s creditworthiness, covered securities provide an additional layer of protection. However, the lower risk involved entails a lower risk premium, and consequently a lower return.
Covered debt instruments are particularly attractive for risk-averse investors in the lookout for stable income flows.
