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Bond market in canada


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Bond market in canada

  1. 1. By – Kartikay Khetarpal 773
  2. 2.  The corporate bond market is an important conduit between savings and investments, enabling borrowers to issue publicly traded debt instruments to finance investment projects and/or spending for general corporate purposes.  The Canadian corporate bond market has become more active in recent years, against a background of low inflation, reduced public sector borrowing, and low long-term interest rates.
  3. 3.  In 1998, net new issues of corporate bonds in Canada exceeded long-term debt issues by the various levels of government for the first time since 1973.  This increased level of activity has been accompanied by the development of new products and greater investor interest in instruments with higher returns and higher credit risk.
  4. 4.  While corporate credit spreads appear to peak in periods of weak economic activity, shorter term fluctuations often reflect changes investors’ preferences for highly liquid securities.  A more dynamic Canadian corporate bond market is a welcome development. It offers borrowers an alternative source of funds, especially firms that have typically relied on the banks and the U.S. bond market.
  5. 5.  The close proximity of the U.S. corporate bond market has contributed considerably to the development of the Canadian market. Most of the U.S. market’s structures, practices, and institutional arrangements have been replicated in Canada. As a result, the market for bonds issued by non-financial corporations in Canada is relatively large by international standards.  Despite the presence of a domestic corporate bond market, Canadian borrowers regularly raise funds outside of Canada, primarily in the United States. This has been particularly advantageous for borrowers with weaker credit ratings, since the United States has a much more developed market for bonds with higher credit risk.
  6. 6.  It is also worth noting that the recent increase in activity in the Canadian corporate bond market has taken place in a period marked by a striking decline in public sector borrowing. In 1998, for the first time in more than 25 years, the private sector issued more bonds on a net basis in Canada than the public sector. This situation is likely to persist in coming years, given the improvement in public sector finances.
  7. 7.  Until very recently, private sector issuers of bonds in the Canadian corporate bond market were mainly well known, highly rated domestic entities such as financial institutions, utilities, and the largest industrial companies with credit ratings of single A or better.  Financial institutions have been active issuers of bonds in Canada in recent years. An important reason for this is that Canadian regulators include debentures in the definition of a deposit-taking institution’s Tier 2 capital base.
  8. 8.  The development of a high-yield market in Canada is particularly encouraging, since it might offer an alternative source of domestic funds for small and medium sized firms that have typically relied on the Canadian banking system and the U.S. corporate bond market for financing.
  9. 9.  Corporate bonds in Canada are held mainly by institutional investors such as life insurance companies, pension funds, deposit-taking institutions, and mutual funds. Life insurance companies have traditionally been the largest holders of corporate bonds  Deposit-taking institutions and mutual funds have become major buyers of corporate bonds.  Since corporate bonds are mainly a buy-and-hold investment for most institutional investors, secondary market activity does not provide much insight into the inner workings of the market.
  10. 10.  Corporate bonds are priced in terms of yield differences over government bonds of similar maturities. The yield spread on a corporate bond compensates the investor for the expected risk of default and investor preferences for liquidity (government bonds are more liquid than corporate bonds).  Although the market for credit derivatives is in its infancy, prices in this market generally change very slowly and in line with fundamental changes in the underlying asset’s credit quality.  This suggests that most of the short-term fluctuations in corporate credit spreads are mainly associated with changes in investors’ preferences for highly liquid securities.
  11. 11.  With the improvement in Canada’s economic fundamentals, its corporate bond market appears to have a promising future. Borrowers should be able to access a larger pool of capital domestically. The development of credit-analysis skills in Canada and more widespread use of credit derivatives might also contribute to the market’s development and may result in more optimal allocation of capital in the economy.
  12. 12.  That said, Canadian companies will likely continue to issue a significant portion of their bonds outside Canada because of their need for foreign currency and the relative ease of access to the deep and active corporate bond market in the United States.  The Canadian corporate bond market has thus, experienced a renaissance, in recent years, against a background of low inflation, reduced public borrowing, and the lowest levels of long-term interest rates in a generation.