Cash for bond lending is a type of arrangement that allows an investor to receive a cash loan by pledging all or some of the bond issues currently held in the investment portfolio as security for that loan. The pledge remains in place until the cash loan is repaid in full, meaning that for the life of the loan the borrower cannot sell the bond issues without the express permission of the lender. In exchange for pledging the assets, the borrower can usually receive superior interest rates and repayment terms that make it easier to manage and ultimately settle the debt.
The use of cash for bond lending may occur in a number of settings, including with national or central banking operations. For example, this type of lending activity is common with the Federal Reserve Bank in the United States. As part of the Term Auction Facility operated by the Federal Reserve, the cash for bond lending approach can allow investors and even governmental agencies to make use of the bonds held in a portfolio to secure loans with a duration that is similar to that of the bonds pledged for collateral.
One of the chief benefits of a cash for bond lending arrangement is that borrowers can make use of assets for collateral that they were likely to keep anyway. While some investors will sell bond issues before the date of maturity arrives, the general idea is usually to hold the asset until it matures and enjoy the interest that is generated over the life of the bond. Depending on the interest rate associated with the bond itself and the cash for bond loan, the returns on the bonds may be sufficient to offset the interest rate charged on the bond. In addition, the lender is more likely to offer a lower rate of interest, owing to the low volatility connected with most bond issues.
For lenders, a cash for bond lending provides a level of security that may not be available with other forms of acceptable collateral. Since bonds are considered one of the safer types of investments, the chances of the asset being less than sufficient to cover the outstanding balance on a defaulted loan are very minor. Since the risk level if kept to a minimum, the lender is able to approve the loan with terms that are superior to those the borrower would receive otherwise and still receive adequate returns from extending the loan.