Credit enhancements are used to improve the credit rating of a bond issue, which reduces the rate of interest that the issuer must pay to the buyer. Some bonds will include a credit enhancement in the form of insurance or a guarantee by another corporation. This usually enhances the safety of the bond. However, the safety of the bond may depend on the financial condition of the guarantor because it is the guarantor who will make principal and interest payments to the investor if the company (obligor) can no longer make the payments.
Example (municipal bonds but same idea): "In contrast to long-term municipal bond markets, conditions in short-term municipal bond markets continued to exhibit substantial strains. Market participants continued to report that the cost of liquidity support and credit enhancement for variable-rate demand obligations (VRDOs)—bonds that combine long maturities with floating short-term interest rates—remained substantially higher than it had been a year earlier.10 In addition, auctions of most remaining auction-rate securities failed. Some municipalities were able to issue new VRDOs, but many lower-rated issuers appeared to be either unwilling or unable to issue this type of debt at the prices that would be demanded of them. How- ever, the seven-day Securities Industry and Financial Markets Association swap index, a measure of yields for high-grade VRDOs, declined to the lowest level on record, suggesting that the market was working well for higher-rated issuers."