(First published Sept. 2002)
A potential financial innovation that I suggest - to avoid clumsy acronyms -
to modestly name ..."the Greenfinch bonds" ;-)
GDP-bonds are potential financial instruments that would allow
to invest directly in a country's economic growth.
Nature, and basic purpose of GDP-bonds
The idea is to create long term securities that would be indexed
on the economic growth of a country, or rather an economic zone
Those securities would have two main purposes:
1) To give those countries (or other issuers)
another source of financing,
and a new financial management tool
2) To give investors an hybrid asset
which has some equity's features (variable
return and / or capital, based on economic
while basically being a bond (it is a debt).
The index would be the Gross Domestic Product (GDP).
This, of course, restricts the potential to geographic zones that respect i
nternational economic statistical standards.
Mode of indexation, nominal rate, maturity
The indexation applies to
* the coupons
* and/or to the capital refund value.
This might create a negative rate problem if the GDP falls.
See below "potential issuers" for possible specific protective
covenants for subscribers.
Two possible types : zero coupon, or with quarterly (or yearly)
(total) Duration : maximum 10 years, as the country's (or zone)
perimeter may change in the meantime.
Nominal rate = the country's or zone's annual GDP variation rate
Normally it will be above the rate of fixed rate bonds.
The price would be determined by an auction (when the bond is
issued) and by market quotation (once listed).
Normally the market price will be higher than the nominal value
on which the nominal rate applies.
Basic rate (on the initial auction price or on the market quotations).
Normally it will be below the nominal rate, and below the rate of
fixed rate bonds.
Real rate: calculated by comparison with inflation indexed bonds.
Potential issuers (and advantages for them)
Sovereign states (and regional international organizations) :
The advantage for them is that if the GDP falls, making tax revenues
tumble, the lower coupon / capital to service and repay the bonds
would partly compensate it.
This could even help revive the economy, by easing the public budget
However, to avoid a loss of confidence by subscribers in case
such a GDP fall occurs, some protective covenant might be included
(floor, ratchet, conversion option...).
Banks: to grant indexed loans of the same duration for borrowers
(small firms, home buyers...) whose income can also rise or
fall in sync. with the GDP
Big firms: same advantage, but as a direct issuers.
Other financial institutions: to meet investor's demand
Potentials bearers (and advantages for them)
Individual savers for their savings plan, directly or through
investment funds (see below)
Investment funds / pension funds and life insurance
Foreign suppliers, which business depends on the zone's wealth.
Foreign central banks
Derivatives and other financial engineering tools
Hedging products (on future or option markets) may be created
that use these securities as underlying assets.
Note: As some gdp-based warrants (economic
derivatives) have already been issued in a small
scale by a few big banks, the reverse opertion, which is
to create synthetic gdp-indexed bonds, is already possible.
Assets splitting (and recombining) would be possible.
That would be done via separate market quotations of each annual
tranche of interest, and of the capital refund value (in fine, or in
Customer targets for these derivatives
Cyclical firms (for GDP insurance in the geographical areas where
they have a high stake).
Individuals (same hedging objective for their asset portfolio or their
Financial institutions and professionals (hedging stocks against
the real economy, to compensate for possible lags, leads or divergences
in their respective evolution)
But a problem arises: is there a real "GDP risk mutualization" as this
risk is systemic and hits all the players in the same way?
That would work if enough speculators act as counterparts.
Moreover, there would be mutualization between the big economic
zones of the world if each one issues this kind of security.
We saw above that, for sovereign states, those bonds would bring
advantagesin budget management, but also would help to self-
stabilize their country business cycle.
Also those bonds might facilitate economic previsions.
Economists always have a problem to forecast the economy's future
growth. Maybe the market for those securities would help them
(hey, I didn't say can replace those experts ;-).
=> In principle (but herd instinct or "rational" anticipation might
distort this), those bonds market value evolution would be an
indicator of the general opinion on the economic
prospects for a given area,
in the next 10 years,
and, if the securities are split into annual components, in a
shorter term or even year by year.
This estimate of the economic prospects by the market would
easily be computed by comparing the market evolutions of the
prices and returns of those GDP-bonds to those of:
Fixed coupon bonds
Bonds which are indexed on current market LT or ST
Bonds with their interests / refunds indexed on inflation
Bonds indexed on other countries' GDP with the same
currency (or with another currency, by taking into account
the evolution of the exchange rates and interest rates swaps
Not forgetting the stock market indexes : compared to
stocks, the market price level of a GDP-bond, and its evolution
(divergence or convergence) would be an indicator of:
* Distortions in wealth anticipations or in income repartition
between stockholders and other stakeholders (other savers /
investors, borrowers, employees and pensioners, consumers,
residents and non-residents...),
* that would allow to better spot the respective rates (thus
the respective risk premiums) of these two assets.
Risks and valuation issues
Here are some risk factors:
Like for any security, its value depends on the issuer's solvency
and on the liquidity of this asset's market.
The price evolution of other assets (stocks, fixed rate bonds,
inflation-indexed bonds, commodities), can influence buying
and selling, thus affect those bonds market prices.
Changing macroeconomic trends would influence prices
(well, it is one of the purposes of those securities to reflect this).
Psychological elements affecting investor expectations
(contagious overoptimism / over-pessimism, about the country
prospects) might distort the prices and valuations
of those securities as it is the case for other financial assets.
There are also specific risks linked to the reliability of
The GDP is supposed to measure how many riches a country
produces in one year, what is called its "value added".
Like about all indicators, it is not perfect.
Some productions are left out (the grey economy, and
all what is produced for self- consumption).
Others are just shifts of activities (things that were free or
self-done can become market products).
The "non commercial" production of the state, municipalities,
charity organizations... is counted at its costs (their employees'
Asset depreciations are not deducted (whence the term
"gross"), nor are some asset losses (catastrophes), nor positive
or negative "externalities" (side effects, collateral windfalls
Also the figures might be rigged, before or after inflation) for
Anyway, whatever the criticisms, the GDP is usually considered the
best, or at least the less bad, measure in town of a country's