Explain how issuers that are sovereign, non-sovereign, quasi-government or supranational raise funds
The idea
Governments fund spending from taxes and, when revenue falls short, borrowing. Sovereign issuers sell bills, notes and bonds, usually by regular auction to build a liquid benchmark yield curve. Debt in the sovereign's own currency is backed by the power to tax and, ultimately, to create money, so it carries less default risk than foreign-currency debt, which must be serviced from export earnings or reserves. Non-sovereign governments such as states, provinces and cities issue general obligation bonds backed by their taxing power and revenue bonds serviced only from a specific project's income. Quasi-government entities, such as government-sponsored agencies, borrow to fund public-policy activities and often benefit from an implicit or explicit government guarantee, so they trade a little above the sovereign. Supranational issuers such as multilateral development banks are owned by member countries, backed by their capital, and typically borrow at very high credit ratings.
A practice question
A supranational issuer, such as a multilateral development bank, is best described as:
- owned and backed by member countries — correct
- a regional government within one countryWhy not: That is a non-sovereign government, such as a state or city.
- a state-owned company in one countryWhy not: That is a quasi-government entity, owned by a single sovereign.
Supranationals are owned by several member countries and backed by their capital, which typically allows them to borrow at very high credit ratings.
A harder one
A city issues bonds serviced only by tolls from a new bridge. These are most likely:
- general obligation bondsWhy not: Those are backed by the issuer's full taxing power, not one project.
- supranational bondsWhy not: Supranationals are multi-country issuers, not local governments.
- revenue bonds — correct
Revenue bonds depend on the income of a specific project, so they generally carry more credit risk than general obligation bonds of the same issuer.
The hardest tier
A sovereign's local-currency bonds are rated several notches higher than its foreign-currency bonds. The best explanation is that:
- foreign investors are always repaid firstWhy not: Priority in repayment does not favour foreign-currency holders in this way.
- it can tax and create its own currency — correct
- local bonds are secured by specific assetsWhy not: Sovereign bonds are backed by the government's general credit, not collateral.
Local-currency debt can be serviced from taxes and, ultimately, by creating money. Foreign-currency debt must be met from reserves or export earnings the government does not control.
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