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.