Q: Please explain what kind of protection insured bonds have. Who insures them? How full is this protection, and what happens if the bond defaults?
K.O, via the Internet
Insured bonds have their interest and principal payments insured by a third party, such as MBIA or Ambac Financial Group. They typically have higher credit ratings than uninsured bonds, with the premium cost passed on to the investor through lower coupon yields.
But those insurers have been downgraded by credit-rating agencies this year because they ran into trouble by moving away from their traditional focus to insure risky pools of mortgages that included subprime debt. The result of this downgrading is that the market has discounted the value of such insurance.
In a horrendous recession, the insurance could come in handy when bonds default, said John Mousseau, vice president with Cumberland Advisors in Vineland, N.J. But for now, insured bonds are discounted in price because of the rating problems of their insurers. As a result, the price of insured bonds isn't much different from comparable noninsured bonds.
E-mail Andrew Leckey at firstname.lastname@example.org.