Corporate Bonds as A Source of Financing for The Global Economy

 

Introduction

Corporate bonds are securities used as means to raise capital to finance corporate activities within an industry (Chen & Cai, 2012).

About emerging markets, corporate bonds are used as means of raising capital to invest in growth and expansion initiatives. In this case, corporations obtain funds that would otherwise be in the form of equity.

The use of financial instruments such as corporate bonds as means of accessing external funding is advantageous because they have advantages over equity-type investments. One advantage associated with using corporate bonds over equity-type investments is the availability of debt financing. Debt investments are viewed to offer high returns compared to stock or equity investments. Corporate bonds are regarded as being attractive in terms of financing new ventures. Moreover, corporate bonds have been shown to reduce exposure to risk through a diversified portfolio.

Corporate bond issuance

Corporate bonds are generally issued by companies and organizations around the world under specific conditions. However, it is important to note that not all companies issue shares of common stock. There are many factors that affect the rate at which corporation issuance occurs. These include interest rates charged on money borrowed, accounting rules that govern how assets are handled and factors that determine market supply of the product being purchased (Chen & Cai, 2012).

The most common condition for issuing corporate debts in developed countries such as the US is the existence of equity capital. Therefore, the country’s shareholding in corporate bonds may be small relative to its economic size. The other factor that has led to increasing demand for corporate bonds in developing nations is access to credit. Since there are fewer capital requirements in developing nations, they can afford corporate borrowing. This means that the interest rates of corporate bonds could be lower than those of equities (Chen & Cai, 2012). This is one of the major reasons why more corporations in developing countries issue corporate bonds as an avenue to fund their operations than use equity or debt.

The two main types of corporate bonds issued around the world include direct versus indirect and floating rate corporate bonds. Direct corporate bonds relate to agreements that come into force between companies and investors. On the other hand, indirect corporate bonds relate to arrangements where companies borrow funds from lenders and then repay the loans through dividends. An example of an indirect bond is a term loan where the company makes payments by way of installments. Although floating rate bonds are offered by corporates, other lenders may make direct contributions or purchase fixed-income bonds. All these bonds carry a coupon or interest rate. Examples of floating-rate bonds are ones where the issuer pays a cash flow for every dollar paid by the borrower.

In addition, corporate bonds are issued and sold in several ways. First, the value of the bonds may be calculated based on the average price of each type of bond. Second, some companies may issue bonds directly to their employees instead of relying on dealers. Lastly, many firms may give bonds to creditors in the form of loan commitments.

Corporate bonds can be made in various forms. Some companies use long-term treasuries to issue bonds while others offer shorter-term treasuries. The longer the maturity date, the higher the interest rate and vice versa. Other companies may also offer a portion of their assets or liabilities as a guarantee in the form of corporate bonds. When corporate bonds are used to raise capital, this means that the company will hold additional capital to allow the business to continue running smoothly. In this case, the company cannot sell its stock at a lower price. On the other hand, this process may make the company have less capital to handle its current needs or the need to expand, thereby making it difficult for it to get rid of excessive inventory and pay off its debts. Finally, some companies may issue corporate bonds to hedge money that it might find difficult to earn from some of the profits generated from its assets. To do so, many companies offer corporate bonds as an alternative to cash flows.

Corporate bonds offer different sources of risks. First, corporate bonds are subject to changes in economic factors that lead to inflation. Inflation forces an increase in interest costs on money borrowed and this may result in the weakening of corporate bonds. Such changes in economic factors may cause bond prices to drop significantly leading to more investors withdrawing from the bond market. Secondly, changes in political regimes often affect corporate bond markets. Governments may impose taxes on corporations and this reduces the ability of investors to meet their obligations. They may also create hurdles in getting access to funding if the governments decide to limit the number of shareholders that a corporation may retain. Thus, the introduction of corporate bonds may lead to reduced capital because the government restricts the number of shares that an individual shareholder may have. Thirdly, changing economic trends may pose threats to an asset that is financed by corporate bonds. If unemployment increases, people who borrow from corporations may run out of funds to buy the interest of corporate dividends. Fourthly, corporate bonds may make a company lose more money when tax charges rise. Tax levels may change from low to high levels and thus reduce the amounts available to make payments. This reduces the company’s ability to meet its obligations. Finally, corporate bonds may become insolvent due to changes in the tax base. New laws may allow corporations to write off their old bonds or even go bankrupt and this may make them unable to make payments. With such occurrences, a company’s ability to fulfill its obligations may fall drastically.

Corporate bonds are also affected by fluctuations in exchange rates. Changes in exchange rates normally arise when central banks raise interest rates at an attempt to cool down inflationary pressures. Consequently, the interest rates of both short-term and long-term debt rise causing more companies to seek loans. Increased lending leads to increased borrowing costs and this affects corporate bonds negatively.

Corporate bonds as a source of financing for the global economy

Corporate bonds as a source of financing for the global economy have enormous potential because of their capacity to help companies and firms find new markets for their products. More companies are realizing that corporate bonds are the easiest mode of financing their operations and more corporations are using them. Companies in emerging economies often lend the required capital.

The key difference between corporate bonds and equity is that bonds are treated like stocks in the United States of America where they can be floated on a stock market. In addition, corporate bonds carry less risk than equity. Furthermore, corporate bonds are exempted from the taxation laws adopted in developed states. This means that corporate bonds can be utilized to raise capital without having to worry about whether it will suffer losses due to high taxation. Despite their positive features, corporate bonds are still faced with challenges in their use as a source of financing for growing economies, including India.

The biggest challenge that corporations face is the level of regulation and disclosure involved. Many companies do not disclose detailed information about their accounts to investors or regulators hence their success. Corporations in developing countries have to overcome these barriers in order to operate correctly. Nevertheless, corporate bonds are used as a source of financing for emerging economies as well as developed countries. Several reasons as to why corporate bonds are preferred as a method of financing emerging and developing economies include improved financial information accessibility, easy accessibility of corporate bonds, efficient pricing of corporate bonds and transparency about corporate bonds (Chen & Cai, 2012).

The most common advantage of corporate bonding across all markets is the speed at which bond markets are able to respond to changes in credit spreads or interest rates. Furthermore, corporate bonds are flexible because they can be tailored to the needs of corporate and local markets by reducing the time it takes to issue bonds. Also, corporate bonds benefit from an extensive range of strategies of raising capital, including cross-border, interconnect, private placement and listing. Corporate bonds are usually priced at a discount relative to equity which offers better terms of payment for the company. This helps in saving costs and giving an opportunity to acquire shares at a discounted rate relative to equity. Corporate bonds can increase access by allowing companies to raise capital using non-dilutable securities relative to equity that limits access to credit. Corporate bonds are preferable for large companies, while smaller companies with limited resources can often turn to equity rather than corporate bonds.

Corporate bonds have a wide variety of uses, including acquisition by foreign investors and corporate mergers and acquisitions with corporations, firms or governments. Additionally, corporate bonds are preferred whenever there is a need for creating liquidity or taking advantage of opportunities that may arise on a global scale. Corporate bonds also assist companies in avoiding bankruptcy and in helping the company to maintain its reputation in the eyes of consumers and investors. Another significant advantage of corporate bonds is that they provide a reliable source of financing during emergencies and times of economic uncertainty. Businesses can use corporate bonds as a tool to ensure stable returns so they can continue operating. Overall, corporate bonds are beneficial because they eliminate risks associated with equity, but do not entail a lot of responsibility when dealing with cash flows.

Corporate bonds as a source of financing for emerging markets

Corporate bonds as a source of financing for emerging markets have huge potential in the sense that corporations can access new markets that may help them grow in profitability. Emerging markets comprise 60% of global GDP and offer numerous opportunities for companies (Chen & Cai, 2012). But with the emergence of the Internet of Things and mobile phones, a trend is known as “smartphones” has emerged that requires smart devices, wireless networks and applications to interact with the environment. It is estimated that 50% of mobile users are using computers, tablets, or smartphones that have created jobs in developing countries. Similarly, emerging markets like China, Brazil and Russia are facing intense competition with the internet and mobile phones. Consequently, a trend of increased use of mobile phones and wireless networks creates immense possibilities for growing businesses (Chen & Cai, 2012).