Finance

Economics of Long Term Finance

There are many reasons for borrowing in the bond market, but the fundamental reason is to acquire long term finance or funds, usually for long-term capital projects (such as the building of a factory or constructing a highway or setting up the infrastructure for a gold mine). The bond market thus facilitates capital formation.

By long term is meant periods of longer than a year and up to 30 years. In some countries, bonds are also issued for 40 years, and in a few countries (e.g. the UK and the USA) perpetual bonds (also called consoles) were issued in the past (these bonds do not have a maturity date). The other reasons for borrowing long-term (i.e. the advantages of borrowing long-term) are:

  • Short-term borrowing entails a series of borrowings, i.e. a new borrowing is required every few months; it is administratively burdensome.
  • The rate of interest may be higher when the rollovers take place. • Short-term funds may not always be readily available on the rollover dates.
  • An issuer’s creditworthiness may decline at some stage in the short term borrowing cycle, and funds may not be available at all under this changed circumstance.
  • Equity finance (which is long-term finance) may at times be too expensive.

The bond market overcomes these financially harmful possibilities. It therefore plays a significant role in the economy, in terms of making fixed investment projects possible, i.e. it facilitates capital formation.