The modern economy seems to be a rather complicated mechanism. No less complex is the system of money, securities and other all kinds of means of payment. Government bonds occupy an important place in this niche, and they can rightfully be called one of the oldest financial instruments. About why the state issues bonds, what types of bonds exist, and also about many other things related to securities market You can read in this article.
The need for additional state funding
Money, as a means of payment, can be compared with the blood circulating in the economy. In other words, without money, or some other analogue of them, the economic system simply cannot function. For any economic activity, commercial or even state, a foundation is needed, financial support. To some extent, government bonds and other securities may well be considered a means of payment.
And if the goal of commercial enterprises is to make a profit, because it is for this reason that they create, work, produce and sell their products or provide services, then it is obvious that the state also needs cash. In addition, it is a participant in this system of distribution of material goods, fulfills its functions and obligations to people, collects taxes and provides other services. As it always happens, sometimes there is not enough money, and not only private business, but also the state can face this problem.
Where to get the money?
Why is it necessary to issue government bonds? Being part of the economic system, the state needs the money that it needs to provide all kinds of management functions. The receipt of money in the country's budget comes mainly from taxes and customs duties. Therefore, in cases where the state needs additional funding, a logical solution may be to increase taxes and other fees. However, such measures do not always give the desired result, because increased the tax burden may provoke a reduction in business activity or force it to hide from paying taxes.
Another solution may be emission - the release by the state of additional money, which, it would seem, will help to resolve all the accumulated problems. But here, not everything is as simple as we would like, because an increase in the quantity of money supply in circulation without a corresponding increase in the production of goods and services leads to the depreciation of money. Inflation makes it simply pointless to issue new bills, since prices are rising, which may even exacerbate the situation.
There is only one way out - to borrow money. Such a solution is advantageous in that you do not need to raise taxes and print new banknotes to raise funds, the influx of which will inevitably lead to inflation.
Bonds as a guarantee from the borrower
Bonds state loan constitute securities, the owner of which, upon expiration of their validity period, the state guarantees the return of the nominal value, as well as the payment of a certain percentage. In this case, the issuer, that is, the guarantor for debt obligations is the state or individual executive bodies authorized to issue securities.Unlike stocks, whose rate is subject to fluctuation, the yield on government bonds does not change, so investing in them seems pretty reliable.
Many countries resort to government loans in order to obtain additional resources and solve financial difficulties. Bonds seem to be a good way to attract investment. If we study the structure of the state debt of developed countries, we can see that government bonds, located both on domestic and foreign markets, occupy most of all debt obligations.
In addition to states, commercial enterprises can issue securities to attract investments. Compared with government bonds, the acquisition of such bonds carries more risks, because in the event of the ruin of such an enterprise, invested funds may be lost. However, in the case of bankruptcy of a legal entity liabilities to bondholders are priority.
Background of bonds. Securities in Tsarist Russia
Perhaps it will not be superfluous to tell the background of the appearance of bonds. The word itself comes from the Latin obligatio, which translates as "commitment." In the Middle Ages, the main financial centers were loan sharks. They could also give their money "in growth." An alternative to money-lenders, whose activities, among other things, were condemned by the church, are bonds that appeared in Holland in the 16th century. Initially, they were analogous to bills, and issued by their merchants, who paid interest on debt obligations from their profits. The terms of repayment and interest on the first bonds were strictly agreed upon in advance.
As for Russia, here government bonds appeared on the initiative of Catherine II. She just conquered the Crimea, however, for this she had to get into debt. Lenders supplying the Russian army demanded settlement, so Catherine was forced to look for money abroad. English and German banks went to meet her, then the first Russian securities were born. The bond market began to develop rapidly since the abolition of serfdom. Active construction of railways was carried out in the country, large enterprises were created - new funds were attracted for these purposes. Bonds were issued by metallurgical companies, banks and Russian rulers, the latter especially needed money during the wars. At that time, the owner of the bonds received about 4% per annum, and their terms of validity usually ranged from 5 to 50 years.
Securities of the USSR
As mentioned earlier, government securities seem to be a fairly reliable means of investing money, but in 1917, after the Bolsheviks seized power in the country, all debt obligations of the Russian Empire and the interim government were invalidated, that is, the new government simply refused to pay the old bills. But already in the 1920s, the USSR government began to issue its own so-called winning bonds, the interest on which was played out and paid according to the lottery principle. Since there were not many people who wanted to buy new securities, their acquisition was made voluntary-compulsory.
In Soviet times, various types of bonds were issued, their mandatory purchase was canceled by Khrushchev, and the debt to creditors was partially repaid only after 1977. Under Brezhnev, winning securities gained some popularity. And just before the collapse of the USSR, commodity bonds appeared in the country, the owner of which received the right in the near future to purchase various goods, for example, household appliances or even a VAZ car. But, as in 1917, after the collapse of the country, nobody really paid for these debt obligations.
Release objectives
Nowadays, a country can issue government loan bonds for various reasons, pursuing different goals. Consider the main ones:
- To cover the budget deficit.
- If necessary, reduce the maturity of previous debt obligations.
- For cash replenishment of the state budget.
- When local governments fund targeted programs.
- To ensure a uniform and uninterrupted flow of tax funds throughout the financial year.
- In the case when various organizations and institutions whose activities have important economic and social significance for the state need financial support.
Types of Securities
Since government bonds are of various types, the investor has the opportunity to choose the most suitable options for themselves, based on their own priorities.
- Interest-bearing government bonds, the rates at which are fixed, and the holder of such securities has the right to regularly receive dividends throughout the entire investment period.
- Securities of a discount type for which interest or any other financial incentives are not provided. However, profits from them can be obtained by earning on the difference between the cost of issuing these securities and their nominal price.
- Registered bonds are issued and registered for a specific person who has the right to dispose of securities of this type at his discretion.
- Coupon securities, also called bearer bonds. A special sheet is attached to them, from which individual coupons are cut off while receiving dividends.
- Winning securities, similar to those that were common in the USSR. There is no yield to maturity of the bond, but their holder gets the opportunity to participate in raffles of various cash and commodity prizes.
In addition, government securities are nominated both in national currency and in foreign ones. Foreign currency bonds have a slightly higher interest rate, while they are not without guarantees of security by the state. Still such securities are market and non-market purposes. The first include notes, bonds, treasury bills, which you can always sell or buy. The bond market is not intended for savings certificates and some other types of bank securities.
Securities may also vary in validity. For example, government short-term bonds usually last from 7 days to one year. Medium-term notes may have a loan maturity of one to five years, and long-term notes are redeemed after 5 years or more. However, such bonds can be presented for payment at any time, however, in this case, interest payments will be significantly lower.
Market structure
A lender who purchases government bonds can be both an individual and a legal entity, and the borrower is the state or some of its subjects. At the time of purchase of securities, a contract is concluded with the lender, which clearly indicates all the conditions regarding the loan repayment terms, interest on payments and other rights and obligations of the parties.
The securities market itself is primary and secondary. Bonds, stocks, certificates and bills are placed on the primary market, that is, on the exchange, where anyone can buy them, of course, if he has the money. All other operations not related to trading on the exchange, when the purchase and sale of securities is carried out through personal contacts or via the Internet, are considered to be in the secondary market. However, today most financial institutions and other serious players work in the secondary securities market or make transactions with the help of intermediaries.
Bond market control in Russia
To ensure the legitimate and stable operation of the securities market, both state and all others, the government is obliged to exercise control over the activities of its participants. In Russia, a special Federal Commission of the Central Bank (FCSM) has been created for these purposes, whose activities are regulated by the Federal Law of the Russian Federation. In each region of the country, special territorial bodies have been created that are subordinate to the FCSM. They have a wide range of powers and are entitled to:
- To issue general licenses to participants of the securities market for the implementation of their professional activities, as well as to revoke and suspend the validity of these licenses.
- Empower local authorities, control their work in this area.
- Qualify securities, types of bonds, as well as determine aspects of their further distribution.
- To establish all kinds of indicators and standards in order to reduce the risks for market participants associated with securities transactions.
- Decide on the liquidation or establishment of additional branches of the FCSM in the regions.
- Monitor the implementation of all the requirements and standards governing the operation of the securities market, participate in the identification of violations, as well as in further proceedings in this regard.
These bodies and commissions, as well as the Federal Law and other regulatory legal acts, also control government bonds of the Russian Federation.
Investing in government bonds
The government bond market may not be suitable for every investor due to a number of its features. Investing in a government loan is the most suitable tool for those who prioritize the reliability of their savings and a stable income than high interest rates, because government bonds usually have low returns.
Today it is almost impossible to find a more reliable way to invest your personal funds than to invest them in government securities. They are under the jurisdiction of legislative acts, which guarantees their stability and reliability - this compensates for the low yield to maturity of bonds issued by the state. Government bonds are highly liquid due to their undoubted win-win, so selling them is not difficult. In addition, the reliability of such securities is due to the fact that they are supported not only by the economic capabilities of the state structure, but also by its assets and property.
Government bonds issued by the state, which is a very common practice in most countries of the world, are considered the most reliable and stable investment tool.
