But bonds are also issued by supranational agencies – the World Bank for example – and large corporations like GEC or Siemens.
These bodies borrow money to fund their activities.
Governments and municipal bodies need money to spend on public goods – roads, defence, health, social security and so on. And for governments and municipal bodies – apart from taxation and selling public assets – borrowing money is one of their few options. And businesses need cash for all sort of reasons – to meet working capital shortfalls, to invest in new products, to expand into new markets and so on.
The question now is: as with any borrower, how can you be sure you are going to get your money back or that they are going to be able to pay you the interest on the loan?
This may seem an odd question in relation to say, bonds issued by the Bundesbank or GEC. But it is clearly not an odd question in relation to debt issued by a municipal authority in a developing country, or a company you have never heard of.
This is where the credit ratings prepared by rating agencies come in – and we will look at credit risk later. But for now the thing to remember is ‘the higher the risk of default, the higher the return the bond’s issuer will need to offer to compensate for that risk’.
In this context, the government debt of major economies – where there is no risk of default - is sometimes said to offer a riskless rate of return. And for this reason, government debt is used as a benchmark against which to judge the return offered by other bond issuers.
