The recent coronavirus pandemic has fundamentally changed the way in which individuals, organizations, and even nations manage their finances.
Most people around the world now know about the devastating effects that a pandemic can have on the overall economy. This is the reason that they want to be financially prepared for such emergencies.
Many different types of financial products have come into existence in order to support this idea. Pandemic bonds are one such type of product that is marketed to fixed-income investors.
It is important to note that pandemic bonds have not been created as a result of the coronavirus pandemic. Such bonds existed at least a decade before the covid-19 pandemic took place.
For instance, the world bank had floated pandemic bonds after the Ebola fever pandemic broke out in Africa almost a decade ago. In this article, we will have a closer look at what pandemic bonds are and how they function.
What are Pandemic Bonds?
Pandemic bonds have been created by World Bank and World Health Organization to help finance the response to global pandemics.
Whenever global pandemics occur, developing countries do not have the funds required to meet the increased expenses. Hence, global bodies such as World Bank and World Health Organizations have to fund the response of these countries towards the pandemic. In order to do so, they require a lot of funds at their disposal.
The pandemic bonds have been created in order to provide these funds to global organizations. In essence, pandemic bonds work as an insurance policy. This means that private investors can buy pandemic bonds from these international bodies that issue such bonds. They need to deposit their cash upfront which will be held by the issuer till the time the bonds are in existence.
Just like all other bonds, pandemic bonds also pay a coupon rate. Sometimes, the coupon rates are significantly higher than the interest rates. Higher rates are offered to compensate for the higher risk which is being undertaken by the investors.
Now, if a pandemic does occur during the duration of the bond, then the investors stand to lose part or all of their principal payment. On the contrary, if a pandemic does not occur during the said timeframe, then the entire principal will be refunded to the investors. Since investors could lose a large amount of their capital, investment in pandemic bonds is often considered to be risky.
The indenture of these bonds contains an elaborate set of rules which need to be met before the bonds are considered to be triggered and the funds at the disposal of the investors are routed to fund the pandemic response in developing nations.
Advantages of Pandemic Bonds
Pandemic bonds have several advantages. Some of these advantages have been explained in the article below:
- Less Reliance on Aid: Firstly, the pandemic bonds help mount a better response to the crisis situation. This is because developing countries do not have to rely on the benevolence of developed nations. Instead, the funding can be sourced from private investors. Such types of bonds are quite helpful in ensuring that adequate funds are made available to the poorest of the poor countries.
- Funds Available at Cheaper Rates: Developing countries do not have the financial wherewithal required to raise funds in order to meet their obligations which may arise as a result of the pandemic.
If developing countries try to raise money from the markets, they will have to pay very high-interest rates.
The involvement of global bodies such as the World Bank as well as the uncertain nature of the event allows developing countries to purchase insurance at a lower cost.
The premium paid can be said to be negligible in comparison to the costs which would have to be incurred in the event that a pandemic does take place.
- Cheap Way to Diversify: There are many investors as well as investor bodies which who want to make investments in pandemic bonds. This is because such bonds have very little correlation to credit risk, market risk, interest rate risk, and such other risks which are faced by other bonds.
Hence, these bonds are a wonderful addition to an already existing portfolio of fixed income securities since they help to stabilize the returns over a longer period of time.
- Reduces the Possibility of a Pandemic: Pandemic bonds are an effective way of keeping the market’s attention on the possibility of a pandemic.
Since a lot of private players invest a lot of money in these bonds, they also keep an eye on the probability of a pandemic actually occurring as well as the research which is being done to avoid the pandemic from actually taking place.
The active participation of the financial markets draws the attention of the necessary players. This, in turn, drastically reduces the probability of a pandemic taking place.
The bottom line is that pandemic bonds are an important financial instrument. They allow global organizations as well as developing nations to respond to pandemics in a timely and cost-effective manner. They also make it possible to fund these responses independently and without the need for any charitable contributions.
Authorship/Referencing - About the Author(s)
The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
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- Yield to Call
- Introduction to Yield Curve
- Inverted Yield Curve
- Bond Duration
- The Calculation of Bond Duration