18 The Management of Bond Investments and Trading of Debt
Indeed, it is easier to do so with classical business lines than with highly geared, illiq-
uid instruments. For instance, we can estimate trend curves with net new money growth
and average margins on assets, for products typically used in private banking and tra-
ditional asset management. But we are less able in computing the potential impact of
derivative instruments used in complex investments deals, whether these are traded
bank to bank, or sold by funds of funds to a growing population of retail investors –
who should know that their future losses are not covered by the socialization of risk.
1.6 Debt management challenges
As we will see in Chapter 2, to a very large extent, globalization, economic develop-
ment and capital flows work on the basis of debt financing. There is nothing awk-
ward in this, because debt is easier to trade than assets. It is also easier to manipulate
debt and create new financial instruments, as compared to assets. But debt handling
should be subject to sound debt management practices.
The amount of debt by governments, supranatural organizations, banks and indus-
trial corporations amounts to trillions of dollars, and this volume strongly influences
the behavior of the global financial system – while at the same time it questions its
long-term survival. To manage debt in an able manner, borrowers and lenders must
have a clear understanding of where they want to base their financial strategy:
Should they promote equity or debt, and why so?
Should they prefer subordinated or non-subordinated debt?
Is it better to contract loans on fixed or floating interest rates?
What type of bonds should they issue to the capital market? Who should be the
What is the preferred currency denomination of debt instruments?
Both at national level and internationally, there are different ways to measure the
costs and risks associated with a borrowing strategy. Discounted cash flow techniques
are very useful,
and the same is true about marking to market the value of debt –
though, as already stated, this is by no means an easy exercise since a good deal of
this debt is kept to maturity (see Chapter 10) and will not be priced by the market at
any early time.
Analytical approaches are important in pricing debt instruments, because they pro-
vide insight and foresight in a world where indebtedness increases at rapid pace.
Research I carried out in the late 1990s documented that in nominal terms the issue
of international bonds grew 25 times, in just 22 years, from 1975 to 1997: From $20
billion in 1975 to about $500 billion in 1997, while medium- to long-term syndicated
loans also increased 20-fold.
A major reason in this trend towards greater debt financing has been the sharply
rising government indebtedness, due to a shift toward major budget deficits and
rather lax fiscal policies, but corporate and private individual debt also rises fast.
Hence, it is most important for lenders and borrowers to steadily test the effects of
changes in interest rates on anticipated cash.
For lenders, the focal point must be income stream commensurate to assumed risk
and market prices.

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