The Value of Credit Enhancements

Credit enhancements include such things as advance refundings, bond insurance, and letters of credit. When a bond is insured, it assumes the rating of the insurer. The higher a bond is rated, the lower its coupon payment will be, so the main reason to purchase bond insurance is to raise the issuer’s credit rating and correspondingly cut its interest payments. Credit enhancements also mitigate liquidity risk.

Bond insurance can be purchased by either the issuer or the underwriter, and it guarantees that investors will receive their interest and principal on time, even if the issuer does not have the funds to cover the payments. 

When determining the cost of coverage, bond insurers will focus on such things as the issuer’s historical