The Meaning of Bond to the Ordinary Ghanaian - ILAPI

We hear financial analysts, economists and media houses mentioning Bonds in their submissions and analyses. Almost everyday someone may come across the word ‘bond’ either from the newspapers, radio or television programs. The question we ask is, do voters really understand the word ‘BOND’ in economics and finance? You should not be surprised if you hear that most media persons do not understand what ‘bond’ means. Most people in the cities, towns and villages both educated and the uneducated do not understand what is meant by ‘Bond’. It will surprise you that most politician make noise but they do not understand the term. You should not be taken aback upon hearing that most graduates do not understand what ‘Bond’ means as well.

A ‘Bond’ is a fixed investment in which an investor loans money to an entity usually government who borrows the funds for a defined period at a variable or fixed rate of interest. Bonds are mostly used by companies, individuals, states or sovereign government to raise money to finance a variety of projects and activities. Owners or holders of the Bond are referred to as ‘debt holders’ or ‘creditors’ and the issuers (government) is the debtor. In the case of Ghana for instance, if Ghana government issues a bond to investors, the government becomes the debtor or borrower and the investors become the buyers or creditors or lenders.

‘Bond’ is also a fixed-income security. When an investor purchases a ‘Bond’, they are "loaning” or lending that money (called the principal) to the bond issuer (government in the case of Ghana). When the Bond matures, the issuer (government) repays the principal to the investor.

In most cases, the investor or lender will receive regular interest payments from the issuer until the bond matures.  In case government needs more money to finance new projects or maintain ongoing operations or refinance an existing debt, she may issue bond directly to investors instead of obtaining a loan from banks. After the bond has been issued, the issuer (government) becomes indebted to the investors (buyers). So, in simple terms, bond can be equated to BORROWING. Every Bond has a stated interest rate that will be paid and the time at which the loaned funds (bonds principal) must be returned (maturity date). The interest rate, also called the coupon rate, is the return that bondholders (buyers of bond) earn for loaning their funds to the issuer (government). Every individual bond has a price called the face value. That is the price at which each bond will be purchased. So, this is how the $1.5 billion-dollar bond about to be issued by the Ghana government could be explained to an ordinary Ghanaian.  

The $1.5 billion dollars is the expected amount to be made after selling the bonds by the government. However, as to whether the government can make up that amount depends on certain factors including the credit quality or worthy of the issuer, the length of time for the bond to mature and the coupon rate compared to the general; interest rate at the time of issue. The above factors determine as to whether bond will be sold at a higher price or lower. For example, because fixed rate bonds will pay the same percentage of its face value over time, the price of the bond will fluctuate depending on the prevailing interest rate at the time of issue. If a bond is issued when the interest rate is 10% at $1000 par value with 10% annual coupon, the bond holder will earn $100 in interest income annually. Here, the bond holder will be indifferent to purchase bond or invest the same money at the prevailing rate. If the general interest rate in the economy drops to 8%, the bond will continue paying 10% as interest so investors will purchase more bonds making the bond prices shoot up to a premium until the effective rate of bond also drops to 8% or below.

Let's look at travelling to India with Ethiopian Airlines. The Airline would issue a ticket to the traveller. The traveller would give the Airline an amount of money as written on the ticket. Once you pay the amount on the ticket, Ethiopian Airlines owes you a travel on a stipulated date and time on it flight. Here, the Government is the Airliner, ticket is the coupon rate and the traveller is the investor just as in Financial Bonds.

In all government is still borrowing but not that of Concessional or Non-Concessional loans as it used to be.