Executive Summary
The primary goal of this research paper was to discuss the innovation of bonds and understand the events and aspects that required modifying their features over different historical periods. The events such as high inflation rate, economic and political instability, and globalization were the major reasons for introducing these changes. Ensuring a high level of safety to the investors by increasing bonds convertibility and flexibility was vehemently important during all phases of changes.
Adding various features required a sequence of modifications while making the bonds convertible and sensitive to the economic environment in the first place. Nonetheless, the need for improving their convertibility and transferability into equity required making these tools hybrid. Despite an extended coverage of risks by the improved version of this financial tool, it did not guarantee the safety of the interactions due to the increasing importance of investors and gravity of international trade and enhancing sensitivity to changes in financial markets. These trends could be viewed as exceptional, as they did not comply with the current solution of hybrid securities.
In the end, these findings underlined that bonds and other financial instruments require continuous improvement. Changing the structure of the bonds and ensuring their compliance with globalization and the concepts of international trade would help avoid misunderstandings and ensure the safety of transactions. At the same time, choosing the most suitable equity and debt component would not only make the bonds more effective but also increase their profitability. Overall, these modifications have to be applied simultaneously since introducing these changes at the same time will have a beneficial impact on the profitability of bonds and attract more investors to the sector.
Background
The financial market has always been viewed as a place, which tended to be a reflection of technological changes and various economic trends. In the past, the bonds and other financial instruments were rather simple, and this aspect defined the fact that the choices for the external financing were rather limited (Allen, Yago, & Barth, 2012). Switching from traditional bonds to convertible ones took place in the seventies due to the rapidly growing inflation rate (Allen et al., 2012). In turn, it could be said that the subsequent phase of the bond innovation was present in the eighties and focused on the essentiality of sensitive bonds (Allen et al., 2012). This change could be explained by the understanding that the equity had a vehement correlation with the bond’s value (Allen et al., 2012). Overall, the need for these modifications was reasonable since the bonds and other financial securities continued to evolve due to their dependence on the economic and technological environment.
As for the current situation with the bonds, today, this financial instrument continues to develop in a positive direction while expanding the options for investors and increasing the number of aspects to enhance prosperity and stability of the firm. The need for the protection of the investors has driven the need for the development of hybrid bonds. This form of financial activity is rather complex, as it implies focusing on both equity and debt features simultaneously (Allen et al., 2012).
Consequently, nowadays, using new forms of bonds could be considered as challenging since having debt and equity constituents increases the number of risks for investors and companies. At the same time, a paramount importance of bonds in acquiring additional capital required for the maintenance of the company underlines the need for continuing study of these financial securities. Gaining knowledge concerning this topic and understanding its working mechanism and potential ways for future development explain the interest in this research and the necessity to study it.
Overall, a plethora of opportunities for the bonds’ optimization and innovation of the financial markets increases the interest in this theme among the financial practitioners and the executives of the firm. A combination of these factors upsurges the interest in this topic, as bonds are vital constituents of the financial market. Subsequently, based on the factors provided above, the primary goal of this research paper is to assess and describe the details about the changes in bonds and rationale for the occurrence of these innovations while referring to the economic environment. Offering these insights will assist in providing the recommendations to the existent issues and gaining a clear understanding of the connection between bonds and other aspects of the economic environment.
Remedy, Responses from Regulatory, Cautions, and Observations
Innovation of Bond: Periods and Description of Securities
In the first place, it is critical to describe each historical change related to the bond innovation separately and provide clear definitions of the novel forms of security. Before the 70s, the market was occupied by stocks, as they ensured a rapid return on investment while having a positive financial impact on both purchasers and firms (Allen et al., 2012). Nonetheless, relying only on this financial instrument was not effective, as it was dependent on the manipulation of the traders and fluctuations of economic cycles (Allen et al., 2012). A combination of historical and financial aspects led to the development of convertible bonds. In this case, this financial tool implied that the bond could be transformed into the equity (stock) during the specific periods discussed in the contracts (Zhang & Liao, 2014). These instruments were appropriate for the firms, who did not have a well-established base of financial activities. Nonetheless, the primary risks were associated with setting a suitable price for these securities during the times of economic recession and political instability (Zhang & Liao, 2014).
Subsequently, the next stage took place during the 80s, and it led to the development of the sensitive bonds. Overall, these financial securities were responsive to the inflation rate and foreign currency exchange rates (Strumeyer, 2012). In this case, making them inflation-indexed and taking into account changes in interest rates increased the safety of using these securities. Nonetheless, they were not the most effective tools in terms of profitability and still posed a threat to the financial stability of the organization.
The current economic stage generated the need for combining the features of debts and equities, as the financial practitioners understood a connection between the problems linked to the fluctuations in the prices of assets (Allen et al., 2012). One of the most common hybrid tools were contingent convertible bonds, as they used the mechanism of the traditional convertible instrument (Spiegeleer, Schoutens, & Hulle, 2014). The primary difference pertains to the fact that the investing party shows interest in changing equity for debt under the particular circumstances (Spiedgeleer et al., 2014). It could be said that this matter has a beneficial influence on the stability of the organization while assuring of debt and equity.
Reasons for Changes
Despite the clarity of the stages mentioned above, it is critical to offer a rationale for the development of these changes. In the first place, the transition between traditional bonds and convertible one pertains to the need for maximizing profits and increasing the safety of transactions. Nonetheless, introducing these changes was not effective. The 1980s were associated with the rise in inflation rates while having a critical impact on the interest rates and the monetary value of bonds (Billi & Kahn, 2010). This economic phenomenon had an adverse influence not only on the bonds’ market but also on the economy as a whole. Being extremely dependent on any fluctuations of the financial environment while questioning their profitability and return on investment. A combination underlined the need to introduce the innovation to the existent bond’s mechanism while adding inflation-indexed component.
Nonetheless, making the bonds sensitive to inflation did not resolve all the issues linked to using these operations while taking advantage of this financial instrument. In this case, the rising popularity of equity markets and their integration with the debt and other financial securities was one of the aspects, which increased the need for hybrid financial instruments (Allen et al., 2012). Simultaneously, the continuous changes in the economic environment such as economic crisis, intensifying rivalry, and changes in the slope of the supply curve defined the need to introduce another type of convertible bonds while linking them to equity. In the end, it could be said that the described bond innovation was driven by the deviations in the external environment, and these modifications were necessary to ensure the safety for investors.
Current Possibilities for the Bond Innovation
It remains evident that the financial continues to evolve since the investors and companies are required to increase the profitability of financial instruments and minimize the number of risks associated with these operations. Nowadays, the issue of the securitization continues to exist (Bloomestein, Harwood, & Holland, 2011). In this case, taking this component into account by introducing an optimal integration between debt and equity components will minimize the risks and attract more investors to the sector.
At the same time, one cannot underestimate the role of the debt issuers and investors in the modern world (Bloomestein et al., 2011). Globalization is a critical definer of the functioning of the markets and makes the presence of international flows a possibility (Bloomestein et al., 2011). In this case, any innovations concerning bonds have to pay vehement attention to this aspect, as it will ensure the safety of operations globally and help minimize risks related to the misunderstandings of the stock exchange in different countries.
Lastly, introducing structural changes to bonds will help decrease the outcomes of the economic crisis and the consequences of the recession stage. This aspect implies that the bonds have to be more flexible and consider other variables of the economic environment including changes in the market capital structure, supply and demand interdependence, and inflation rates (Bloomestein et al., 2011). A combination of these factors will have a beneficial impact on the levels of security and ensure the safety of transactions.
Conclusion
Overall, the conducted study revealed the nature of the bonds and the reasons for their innovation. In this case, in the first place, the investors were interested in using traditional bonds, but it minimized their investment opportunities and questioned the level of security. In this case, it was reasonable to optimize their working mechanism and make them convertible since it allowed maintaining connection between equities and debts. Nonetheless, high inflation rates during the 80s defined the need for making the bonds responsive to inflation by adding sensitivity as one of the most critical features of this financial instrument. Despite the positive intentions of these modifications, this matter questioned the security, as these operations still involved an extended number of risks and threats. In this case, making them hybrid while combining the concepts of debt and equity increased the levels of safety when being involved in these transactions. Simultaneously, hybrid bonds shifted the degree of attractiveness for investors and pulled additional resources to the capital markets.
Despite the existence of the vast variety of instruments, the clarity of bond’s mechanism continues to improve in a positive direction. In the first place, the policy makers have to focus on safety, as this issue continues to exist. Alternatively, paying critical attention to the structural changes and gravity of globalization in the international operations will help improve the safety of transactions associated with bonds. Considering these trends will assist in optimizing the structure of these financial securities while finding the most suitable combination of debt and equity components. Furthermore, taking into account these tendencies will not only help enhance their structure but also will contribute to avoiding adverse consequences in future when operating internationally. Overall, it is possible to theorize that focusing on these matters will attract more investors to the market while enlarging these opportunities globally.
References
Allen, F., Yago, G., & Barth, J. (2012). Financial innovation. Upper Saddle River, NJ: Financial Times Press.
Billi, R., & Kahn, G. (2010). What is the optimal inflation rate? Web.
Bloomestein, H., Harwood, A., & Holland, A. (2011). The future of debt markets. OECD Journal: Financial Market Trends, 1(2), 1-18.
Spiegeleer, J., Schoutens, W., & Hulle, S. (2014). The handbook of hybrid securities: Convertible bonds, coco bonds and bail-in. Hoboken, NJ: John Wiley & Sons.
Strumeyer, G. (2012). Investing in fixed-income securities: Understanding the bond market. Hoboken, NJ: John Wiley & Sons.
Zhang, W., & Liao, P. (2014). Pricing convertible bonds with credit risk and regime switching and numerical solutions. Mathematical Problems in Engineering, 1(1), 1-13.