A bond is an IOU issued by a company, typically offering a fixed rate of interest and a fixed date for repayment by the issuer. In the event of the issuer going bust, bond holders have a higher priority than, say, shareholders when it comes to getting their money back.
A covered bond is one that is backed by other assets held by the issuer. These may include mortgage loans. The idea is that the interest repayments by mortgagees are used to cover the interest to bondholders. The issuer would typically be a bank or building society.
In the event of the bankruptcy of the issuer, a covered bondholder may also have first recourse to the underlying mortgage assets.
Another way to describe a covered bond is ‘securitised’ – the bond’s cash flows are secured on other assets, here mortgage loans.
• See Tim Bennett’s video tutorial: Bond basics.