Some recently launched, or proposed, bonds suggest that the fixed-income world is allowing its fantasies free rein, notes Lex.
This month, $1bn of bonds were issued to finance child immunisation in developing countries, to be repaid from aid. One development bank urged countries to issue debt instruments that permit lower payments in the event of financial shocks.
The aims are laudable but Argentina’s experiment in linking bonds to economic performance demonstrates the challenges involved. Holders of the GDP warrants receive a payment contingent on the relative level of GDP and its annual growth being higher than a specified “base case.” Valuing these warrants is testing, requiring investors to estimate the long-term trend for real GDP growth, and the speed at which it reverts to this trend. Small changes to these inputs make a huge difference to fair value estimates.
There is every reason for emerging markets to embrace more imaginative debt techniques. For investors, it means more risk and more reward – but also a great deal more valuation work.
