Modern finance engineer’s solution that are more complex and therefore harder to understand. Let’s look at the humble bond, where did it come from and how does it fit in today’s complex investment world?
Two hundred years ago, before today’s technology revolution, we were in the midst of the industrial revolution.
Railways are a great example of what a bond is and offers.
Building railroads is expensive. They have long lives to generate an income but are costly to build.
The builders of railroad’s wanted to avoid selling too much equity and needed more money than they could raise by selling shares alone, so they borrowed. In return for loans, companies bonded themselves to investors and promised to repay borrowed money at future dates. Companies documented their promises with bond certificates.
Bond coupon rates varied among companies and varied through time. Like today, investors demand higher interest rates from riskier companies.
According to a historical bond database in the past 185 years, railroad companies have issued bonds in denominations ranging from $2 to well over $1,000,000.
Bond issuers realised two things over this time.
One, it is easier to deal with a small number of large denomination bonds; however
Two, the average investor prefers small-denomination bonds.
Railroads decided $1,000 bonds were the best balance of sales and operating problems. Nowadays, institutions are the gatekeepers for large number of investors so as a result truth one trumps truth two. Therefore, the minimum in the market is $100,000 or even $200,000. The mega-wealthy rule in bond markets. This we hope to change.
In the past a private investor could buy a railway bond and earn the coupon but not anymore. Financial services have developed middlemen, barriers to entry and dealing rules that prevent private investors lending to big business.