Question

Assuming the government is selling a government bond to fight COVID-19, and at the same time, ASHANTI Goldfields Company is selling a corporate bond to increase its production. Under what conditions will the production-linked corporate bond be oversubscribed at the expense of the government bond. Explore all possible scenarios. [Not more than one-page]

Answer 1

Bonds are debt instruments which are sold by institutions and are paid in full to the holder on maturity. Usually risk and return decide the demand for these instruments in any market type.

The government and the company listed, both require funds to be able to meet up with their capital requirements. The government on one hand requires additional capital to be able to spend on meeting infrastructure and health care needs during the pandemic, and the company requires the same to extend production.

The trade off of any investor while purchasing and selecting one among the two bonds is the risk factor and the expected rate of return for both options listed. Here, the government bond would likely be available at much lesser risk as compared to the bond being offered by the company. Yet, the total dividend yield because of this very safety feature of government bonds would be much lesser in comparison to the bond being sold by Ashanti Gold Fields. It is also to be remembered that government bonds often sell for a premium whereas, bonds issued by private companies are normally issued at a discount.

Thus, if with a total investment of 200$ the return on Ashanti Goldfields after a year are 20$, and that of the government bond is 5$ only, the sales of the later are going to be much higher in comparison.

We can conclude by saying, that if the companies returns are higher than that of the government bonds, and people are risk taking or believe that the prospects of the company in increasing production and getting better profits is more, then it may sell in a higher volume than the government bond respectively.

Please feel free to ask your doubts in the comments section if any.