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Why we need an established bond market

Fahmida Rawshan
AMIDST the stock market debacle in recent years, many financial experts may have felt the need for an established bond market to offer alternative options of investment for the investors. Bonds, though they have worldwide popularity as security, have little impact in the securities market of Bangladesh with trading of only a few enlisted bonds.
A bond is a fixed income security which provides fixed interest. If we categorise investors into groups of risk averse and less risk averse, bond as a security is comparatively safer than stock for a risk averse investor as it pays both principal and a certain percentage of interest. Unfortunately, Bangladesh is yet to develop a strong bond market. Neither the policy makers nor the corporations have shown any substantial interest in bonds. In the absence of significant number of bonds, general investors have little idea about how a bond works.
How can investors be benefited from bonds? Firstly, they will receive periodic interest in the form of coupon rate (of course there is zero coupon bond which is issued at a much lesser price than actual face value, which compensates for coupon rate forgone by the investors). Coupon rate is an interest rate which is close (or in general a little bit higher) to the market rate at the time of issuance of bond. Say, a bank offers an interest @ 12% per annum for FDR. So, naturally, corporations will be interested to offer little bit more than what the bank offers to make investors attracted to bonds while at the same time preserving their own interest to obtain funds at a lower cost than available from bank. Investors will get these interests quarterly, semiannually or annually as per terms of the bond.
Secondly, investors can be benefited
from capital gains. How does this happen? Simply consider that the banks' offerings against FDR are lowered to 9% p.a. from previous 12%. This would mean higher return for investors against their invested fund, which will ultimately push the bond price upwards. Thus, capital gains can be made from selling bonds at a higher price than purchased price before maturity.
There are other attractions of bonds too. As mentioned earlier, higher stability compared to stock makes bond attractive to risk averse investors. Consider some one planning for retirement. Isn't it better for him or her to invest in less volatile securities like bond? The fact that bond pays periodic return that is certain in amount makes it easier to set savings targets and better estimate of return on investment. Or how about planning for higher education for children with a zero coupon bond with a known return at the end of bond maturity?
So far, we have focused mainly on the perspective of investor's benefit. But bond can also play a role in macroeconomic wellbeing. The above discussion indicates that bond market is an alternative channel for raising funds as a debt that lessens excessive reliance on banks for funds. Corporations suffer greatly when there is liquidity crisis in the banks and bond is their only source of funds. Wouldn't it be a matter of comfort if there were an established bond market? For investors too, it is an alternative option to invest their funds in other institutions than banks. Thus, bond market obviously has beneficial impact through diversification of credit and investment risks. Besides, a well developed bond market reduces banks monopoly over interest rate on both deposit and credit by offering alternative options.
It is imperative to have long-term instruments for a market to be efficient. A
bond, being a long term security instrument, helps to fulfill these conditions. Although there are some government issued debt instruments that mainly deal through primary based activity, corporate bond market in Bangladesh is still at its infancy. There are only 3 corporate bonds currently operating in the country - I BBL Mudaraba Perpetual Bond, ACI Zero Coupon Bond and Brae Bank subordinated Bond.
One may think that this number is surprisingly low in a financial market that has fair prospect of growth. Thus, proper initiatives need to be taken to develop a corporate bond market in Bangladesh. Some of these initiatives as recommended by experts could be as follows:
Reduction in the interest on government savings instruments (NSD certificates) that act as a benchmark for the corporate sector to offer return on bond. The emphasis should be on encouraging corporations to participate in this market rather than competing with the government;
Presence of a fully functioning regulatory body such as the BSEC that will monitor accountability, transparency and compliance issues of the bond issuing agency and their trustees;
Regulation of stock brokers, subbrokers, share transfer agents, merchant bankers, underwriters, portfolio managers, investment advisors, and other intermediaries who are associated with the securities markets;
Enhancing the number of primary dealers along with their underwriting capacity.
Hopefully, the policy makers will come forward to encourage the listing of bonds, especially corporate bonds, in the securities market to bring benefits both for the investors and the securities market itself. The writer is a student, MBA programme, Department of Finance, University of Dhaka.