Issuers of Bonds: Identifying Them and Understanding Their Purpose along with the Varieties They Produce
In the world of finance, bonds play a crucial role in funding various projects and investments. This article aims to shed light on different types of bonds, focusing on government, corporate, and quasi-government bonds.
Credit Risk and Creditworthiness
When considering these bonds, credit risk is a key factor. Sovereign bonds, issued by national governments, generally have lower credit risk if the country is stable and creditworthy. Local government bonds, on the other hand, depend on the credit profile of the municipality or region, which may vary widely. Corporate bonds encompass a wide range, from high-quality investment-grade firms to high-yield (junk) bonds with higher default risk.
Quasi-government bonds, issued by entities closely linked to governments but may have varied backing and credit profiles, often have a default risk analysis that resembles that of sovereigns but also depends on the specific issuer. Supranational bonds, issued by entities like the EU or World Bank, are considered somewhere between sovereign and corporate bonds in risk, often benefiting from multilateral backing but lacking typical sovereign powers such as direct taxation, influencing their risk.
Yield and Risk Premium
Higher yields typically compensate for higher credit risk. Investment-grade bonds (sovereign or corporate) yield less but offer greater safety. Yield spreads, the difference between yields on bonds with different credit qualities, are crucial for assessing whether the extra return justifies increased default risk.
Issuer Characteristics and Institutional Features
Sovereigns have taxing power, giving them a structural advantage in honoring debt. Supranationals, though backed by multiple countries, may lack taxing power and rely on member contributions, affecting liquidity and appeal in the bond market. Local governments and quasi-government issuers’ repayment ability depends on local fiscal health and political environment. Corporations’ creditworthiness depends on their financial position, management, and sector risks.
Liquidity and Market Accessibility
Sovereign bonds tend to be more liquid and widely traded. Supranational bonds, especially if issuances are temporary (like the EU bonds scheduled to end issuance by 2026), may have reduced liquidity and market appeal. Emerging market and local government bonds may have less market depth, higher volatility, and currency risk if denominated in local currency.
Economic and Political Stability
Political stability, governance quality, and geopolitical considerations directly affect sovereign, quasi-government, and local government bonds. Corporate bonds bear company-specific risks and sectoral cyclicality, while supranational bonds’ stability is tied to the collective economic health of member states.
Currency Risk
For international or foreign bonds (including many supranational or emerging market bonds), currency fluctuations can materially affect returns beyond credit risk.
In summary, the choice involves weighing the trade-offs between credit risk, yield, liquidity, and economic/political factors specific to each bond type. Sovereign bonds typically offer safety with lower yields; corporate bonds offer varied risk-return profiles including high-yield options; supranational bonds combine features of sovereign and agency debt with unique institutional risks; while local government and quasi-government bonds add regional and issuer-specific risks that must be evaluated carefully.
Examples and Ratings
Government bonds are considered less risky than corporate bonds due to their lower default risk. Local governments issue non-sovereign bonds to finance projects in their local areas, such as roads, airports, ports, schools, and infrastructure improvements. Sovereign bond ratings vary between countries, with developed countries like Singapore, Australia, Canada, Germany, Norway, Sweden, Luxembourg, the Netherlands, and Switzerland having the highest ratings.
Bonds can be issued by national governments, local governments, quasi-governmental institutions, supranational institutions, and companies. Corporate bonds come from companies, including financial and non-financial companies, and are used for various purposes, such as financing capital investments, working capital, refinancing maturing bonds, or replacing expensive bonds with cheaper ones. Supranational organizations, like the European Investment Bank, issue bonds to fund their operations and projects.
Local governments repay bonds through local taxes under their jurisdiction or from the cash flows generated by the projects they finance. The World Bank, for example, has issued bonds since 1947 and had total borrowings of $256.9 billion as of June 30, 2022.
Government bonds can be issued in local or foreign currencies, with foreign currency-denominated bonds having lower credit ratings due to translation risk. Local governments can be federal, provincial, or municipal. The United States, United Kingdom, and France have ratings of AA+, AA, and AA, respectively.
Issuing bonds is a way for entities to raise money for various purposes, such as financing budget deficits or investments. Corporate bonds are considered riskier than government bonds due to their uncertain income and higher default risk. National governments may print local currency to redeem local currency bonds, but not foreign currency bonds. Quasi-government bonds are usually guaranteed by the government and receive a higher credit rating than unsecured bonds.
Bonds are fixed-income securities, serving as alternatives to assets such as stocks, real estate, or alternative investments.
Investors must assess the risk-return trade-offs for each bond type, including credit risk, yield, liquidity, and economic/political factors. Sovereign bonds, offering lower yields and safer investment, are less risky than corporate bonds, which encompass a spectrum ranging from high-quality investment-grade to high-yield (junk) bonds with higher default risk. The creditworthiness of corporate bonds depends on the company's financial position, management, and sector risks. Meanwhile, supranational bonds, like those issued by the European Investment Bank, hold a unique risk profile that combines features of sovereign and agency debt, influenced by the collective economic health of member states. Local government and quasi-government bonds have region- and issuer-specific risks that call for careful evaluation.
