What is a performance bond? A performance bond, sometimes called a guarantee bond, is an insurance bond issued by either an investment firm or an insurance company to assure satisfactory completion of a particular project by a licensed contractor. The bond itself is often referred to as a security deposit of trust funds, designed to secure a future contract, often referred to as margin. This deposit will be used as collateral for the contractor’s obligations to the insurance provider. If the project isn’t completed as agreed, this deposit is returned to the investor.
There are a number of different types of performance bonds, and it helps to know what is a performance bond before beginning the process of selecting a provider. The most common types are specified below. These include: First Issue, Past Issue, and Option-based. When speaking of these terms, remember that an Option-based bond is one in which an investor can choose to sell their bond at any point prior to its maturity date, with the option to buy it at the same price at any point after. A First Issue bond is the most simple to understand, and those who purchase it are typically doing so with the long-term view in mind.
One example of this type of bond is the First Issue bond. Issued by financial institutions such as banks, these funds are managed by highly trained professionals who invest their time and money in a variety of issues. While they do not promise high returns on investment, the funds are intended for use by those who need funding in large amounts. Typically, these are small to medium-size investors who have a desire to participate in the stock market but do not need large sums of cash to do so. The funds are then sold to institutional risk-takers, who then pay regular returns to the investors.
The First Issue bond originates from the funds managed by the bank. The funds are managed by professionals who make their living analyzing the risk-takers in the markets. Because the banks that issue First Issue Bond funds typically control more than $10 billion of assets, the funds are high yield, and thus, tend to attract higher rates of interest. While the returns may be high enough to justify the high risk, there are also many restrictions placed on how the money can be spent by the risk-takers. For example, the bonds must be earmarked for special uses by the investing professional investors and must be held at a very low cost to the fund.
Another type of what is a performance bond is the Last Issue bond. In a Last Issue bond the company issuing the bond is not interested in collecting regular payments but is interested only in gaining more profit by making an investment in the bond. This type of bond often times pays a higher rate of interest, has less restrictions than the First Issue bond, and offers flexibility for the investor. In recent years the trend has been that the Last Issue bond becomes a secondary market to the First Issue bond. Some examples of Last Issue bonds are municipal funds, corporate funds, and bonds issued during a bankruptcy proceeding.
In a Reverse Marketability bond there are minimum requirements for the underwriter to determine the maximum amount an investor will pay if the bond issues in the secondary market. Usually these minimum requirements set a minimum return rate, term of the bond, and coupon rate. Usually these minimums are set for ten years. There are advantages and disadvantages to both types of bonds, but if you are an investor looking to diversify your portfolio, investing professional investors with years of experience in this area of bond investing, they are the best choice for you.
The last type of bond – Over the Counter-Bonds – are considered unsecured in nature and are traded over the counter. This means that they can be traded twenty-four hours a day around the clock. Because these investments do not have up to date payment information as with First Issues bonds, they are not as stable as First Issue Bonds but offer an excellent opportunity for investors to create diversification in their portfolio. As with anything, always read the fine print carefully and consider all the pros and cons of any investment before investing. As with any investment, if you do not know what you are doing, it is better to stay out of the market until you are sure you understand the risks and opportunities involved.
When an investor does invest in Over the Counter Bonds they usually are doing so as an affiliate of a company who will pay the commission to the broker or bank on a yearly basis. While this commission is typically low compared to what you would pay a stockbroker, if you take the time to learn about the market and your particular investment options, you will find the opportunity well worth the expense. The first thing you need to do before investing in Over the Counter Bonds is to become familiar with all the risks and the different types of investments available to you. Once you have educated yourself on these important topics, you will then be able to make an informed decision as to what is a performance bond and how it can fit into your overall investment strategy.