A matter of debt

Debt. There's currently about $237 trillion of it worldwide – a new high.

Debt in common parlance generally refers to the cash you may get from your bank to buy a house or a car. However, these days a different form of debt springs to mind – one that makes up a larger proportion of that $237 trillion figure than even the fanciest mansions or vehicles. I'm talking here about bonds.

A bond is essentially a form of debt for corporations and governments, where the buyer of the bond (usually banks) is loaning money to the issuer for a fixed period of time. At maturity, the value of the bond is repaid, including interest payments (coupons) paid at pre-determined intervals throughout the lifetime of said bond. For example, if a government issues a 5-year, ￡50m bond with a coupon rate of 10%, it is saying, "In five years, I owe you ￡50m, and every year until then I will pay you ￡5m interest."

One of the differentiating characteristics of bonds over other forms of debt is the fact that it's fungible and tradable. In other words, at any time before the issuer pays back the original amount and redeems the bond, investors are able to sell their share in the debt to others. Furthermore, the bond has a face value (usually what it is sold for initially), and a market value which fluctuates based on the risk profile of the issuer, among other factors. As a result, investors can make returns on their bond investments, which is called the yield.

When we think about trading activity on capital markets, our mind often more easily gravitates towards images of trading floors on traditional stock markets. Bond trading is a bit different – generally conducted by voice "over the counter" between a smaller number of broker participants. Certain classes of high quality bonds do however often form the basis of collateral in use for repo arrangements between banking institutions.

While these uses in capital markets are all well and good, we shouldn't forget that at their heart, bonds are loans there to support enterprises adding value to the real economy – whether that's bonds promoting climate projects or bonds used to support microfinancing around the world.