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A surety bond serves as support to further guarantee that a principal will perform on its fiduciary duty to an obligee. The principal is the party who issued the bond and therefore owes the obligee repayment on that bond. Cash bonds involve only two parties, whereas a third party insures a surety bond.
Surety bonds are commonly used by banks and insurance companies when additional guarantees are needed to prevent fraud or malpractice.
Unlike traditional bonds, surety bonds mitigate the burden and risk of producing a large sum of cash one time. The surety fronts cash to meet the bond requirements. Sureties require a healthy credit rating and surety bonds carry higher interest rates than cash bonds. Many states have capital requirements for financial institutions, insisting that those entities obtain a surety bond or trust to provide liquidity to investors.