Raising Finance Using Bond Markets | Head Start in A-Level Economics

In this introductory video for A Level Economics students we explain the basics of how business and governments use bond markets to raise debt finance.

Okay hi there and welcome in this third video in our series of short videos looking at aspects of financial economics as part of the head start course uh we’re going to be exploring the bond market when a business needs to raise new money extra finance they have essentially two main options particularly they’re well established businesses one is to either go to

Their private or public investors and raise equity finance through the issue of new share capital issue of new stock which carries voting rights an alternative is to go to the debt markets to go to the bond market in particular and issue a bond which is essentially a loan which requires paying interest to the bond holder sometimes loans require also some form

Of security at the time of issue now the bond market includes lots of different agents looking to raise money companies governments go to the bond market to fund the gap between what they spend and how much they take in in tax and also non-profits such as some schools and universities that can raise money by issuing bonds essentially that’s borrowing money and

Interest from investors here’s a really good example from back in 2017 oxford university uh went to the bond market and uh they had uh they raised a lot of money 750 million pounds with a 100 year old bond wow and they only paid 2.5 interest suggesting that uh this was a a good bet for investors a safe secure loan and just recently i found an article from the

Ft in january 2020 saying they’re planning to go back to the bond markets so with interest rates falling on debt oxford may be perhaps going and buying some more money the ft couldn’t even be bothered to change the photo of the university so we’re going to be taking a look at the bond market in particular there are two main types of bond to focus on the first is

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Corporate bonds issued by businesses corporations and the second is the bonds that are issued by sovereign governments when they have to cover any shortfall between their spending and their tax revenue a corporate bond is typically a lower to medium risk loan made to companies the bond paid interest and the bonds credit rating essentially the risk of default is

Assessed by organizations known as credit ratings agencies a good example would be standard and poors or moods if we think about the growth of a company and the available source and scale of finance or funding corporate bonds are not not for the early years of a company typically when a company is growing at inception and the early growth rates they typically use

Bank loans overdrafts credit cards perhaps things like business angels and crowdfunding now we’re not going to cover those in our short course but uh there’s a lot of videos on the choose to youtube channel that look at those different types of business finance if you look top right of this diagram you’ll see that corporate bonds typically are the favored way

Of raising debt finance for well-established growth mature companies a government bond is a bond a loan issued by a government again to finance their spending on health education defense and welfare the debt is called the bond and the debt is then traded in the market after it’s been issued so we’ll look at an example of this but if the government issues a bond

Once it’s issued it has a price and if you need to buy and sell the bond there is a secondary market where you can go into the market and buy and sell although the price can rise and fall so quick look at the bond market a bond is a loan hopefully that’s familiar now to you the bond is repaid when the loan is repaid when the bond matures so maturity is the date

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When the bond comes up for repayment and each year whoever is holding the bond gets interest the market trades the bond after issue let’s take an example of a truly global business that might need to raise money let’s consider jitter to you issuing a 1 000 bond and they’re probably issue let’s say a hundred of them to raise a hundred thousand pounds so we go to

The market we offer 80 pounds interest to investors and this bond is repaid in 2025 in other words it’s a five-year bond at the time this video is being recorded 2025 is the date of maturity now the yield on the bond is 80 pounds interest divided by the market value of the bond so if i’m paying 80 pounds interest to a bondholder and the bond is worth a thousand

Pounds while 80 over a thousand is an 8 yield effectively the interest rate on the bond the interest by the way is paid annually on a set date to the bondholder now the interest is fixed so when i’m issuing this bond i’m offering 80 pounds per year to whoever holds who owns the bond let’s say on the 1st of june each year so the interest is fixed but the yield

Isn’t bonds are traded in the market once i’ve issued this bond the bonds price can go up and down depending on the strength of supply and demand so for example if the bond was to go to two thousand pounds price because of strong demand i’m still only paying 80 pounds interest can you see what happens to the yield if i’m still paying only 80 interest on a 2000

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Pound bond what happens to the yield well the yield comes down to four percent on the bond the date of maturity is really quite important so one year bond is we paid after 12 months a two-year bond we paid after 24 months so 10-year bond if we issue it this year it’s repaid in 2030. a 20-year bond is issued this year so we paid in 2040 and so on once we get

Beyond 10 years and 20 years we call those long dated bonds because the date of maturity is a long way off in the future there’s even something called an undated bond otherwise known as a perpetual bond that bond is never repaid it just pays the annual interest in perpetuity whoever holds the bond gets the interest something close to it might be a war bond so

In 2014 the uk government paid off some of the war bonds that issued 100 years prior to that at the start of the first world war there we go there’s an introduction to the bond market we’ll take it a little bit further in our next video

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Raising Finance Using Bond Markets | Head Start in A-Level Economics By tutor2u