Bonds

Both companies and governments can issue bonds when they need to borrow money. The issue of new government debt is done by the central bank and involves selling debt to capital markets. The bond market is also the place where companies may seek to raise funds by issuing new tranches of debt.

The bond market has becoming increasing important in discussions about macroeconomic policy both in the UK and many other countries. For example the Bank of England’s policy of quantitative easing has had a direct effect on the UK ‘gilts’ markets with the central bank acting as a major purchaser of newly issued government securities, driving demand and bond prices higher whilst having the short term effect of keeping bond yields (interest rates) a little lower than they might otherwise be.

With many governments around the world running up huge budget deficits and higher levels of national debt, the economics of bond markets has never been so topical. For the UK in particular one of the crucial issues is whether the government is seen as having a credible plan to reduce state borrowing and the possible risk to the UK’s triple A (AAA) credit rating).

Europe’s single currency has reached a cross-road with the financial crisis facing Greece which has now had to ask for emergency conditional loans from the International Monetary Fund (IMF)

The corporate bond market is huge. As of 2009, the size of the worldwide bond market (total debt outstanding) is an estimated $82.2 trillion, of which the size of the outstanding US bond market debt was $31.2 trillion according to Bank of International Settlements.

Basics on the bond market

* This is an international wholesale market where bonds are bought and sold.
* 90% of bonds are held by institutional investors such as insurance companies, pension funds
* 30% of new bonds are issued in the London capital market
* London has a 70% market share in global dealing in secondary bonds (already issued)
* The main issuers of bonds are large companies and national governments and international organisations
* Fixed interest bonds - pays the holder of a bond a fixed cash payment every six months
* Index-linked bonds - interest payments and the loan itself is adjusted in line with the retail price index

Rating bonds

All bonds rated between AAA and BBB are called ‘investment grade’, and are at the lower-risk area of the bond market.

Bonds rated BB or below are labeled ‘high yield’ or ‘junk bonds.’ A junk bond will offer attractive interest payments but the company behind it could well go bust- leaving the investor with nothing.

Equities tend to offer a higher return over the long term but are more risky in the short term (Since 1900, the average annual return on equities has been 5.6% in real terms. For UK government bonds it has been 1.3%, according to the annual returns report by the London Business School and the investment bank ABN Amro).

Here are some recent examples of bonds in the news

Thomas Cook raises £650m through first bond issue (April 2010)
Russia raises $5.5bn via first Eurobond sale for decade (April 2010)
Greece raises 5bn euros from bond issue (March 2010)
UK credit rating viewed as safe (March 2010)

Check below for related blog articles