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What are war bonds, and how do they work?

In times of war, governments sometimes need to appeal to the public for funding. One of the ways a country does this is by selling ‘war bonds’. War bonds are a way for the government to raise money for its war effort, and also a way for citizens to support them. Bonds can be bought by individuals, businesses, or other investors.

War bonds are therefore debt securities issued to finance a country’s war efforts. The government sells the bonds to citizens and other investors, using the money raised to fund the war. They have been used as a tactic for many years and often give the country the boost they need to stay afloat.

 

The United States issued their first war bonds in 1917 to help them in World War I: They were called defensive bonds and were further referred to as liberty bonds in the United States. The U.S. issued these liberty bonds again after the attack on Pearl Harbor and raised a total of $21.4 billion. Britain also sold National War Bonds to aid their military efforts during this time. They offered a 5% yield, and effective advertising campaigns led to about 120,000 sales.

 

With time, more and more countries have adopted this method of funding.

 

During World War II, the United States renamed defensive bonds as war bonds. They again sold the debt securities to over 80 million Americans, generating over $180 billion in revenue to fund their war efforts. Another example from WW2 is when Japan sold their own war bonds after occupying Singapore.

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War bonds are issued as government bonds or treasury bills. The government sells the bonds at a discount, and the buyers earn interest. The government repays the bond with its agreed interest (or ‘coupon) over the time agreed time frame.

 

Ukraine has embraced the concept and is using it to leverage worldwide support in its warwith Russia. It sold a first batch of war bonds on March 1st to finance the military and civilian war efforts. Althea Spinozzi, Senior Fixed Income Strategist at Saxo Markets, said the following about Ukraine’s war bond strategy; “Ukraine sold $270 million worth of ‘war bonds’ in local currency. Yet, foreign appetite remains untested. The country might have a brief window of opportunity to test foreign demand before volatility intensifies in bond markets.”

 

The sale was part of a more extensive fundraising campaign to capitalize on domestic and international backing for Ukraine as the war continues. The Russian government is also attempting to increase sales of war bonds – but first needs to eliminate‘bottlenecks’ in the banks managing the sales, according to Yuri Butsa, the country’s debt chief. Russia may well issue bonds in Dollars or Euros designed to entice foreign investors.

 

The March 1stwar bond yielded 11% and had a par value of 1,000 Hryvnia, or about $45. Ukraine’s outstanding bonds plummeted to trade at 30-35 cents on the Euro and Dollar during the Russian invasion, placing them firmly in distressed territory.

 

The Kyiv government might find it challenging to sell traditional bonds using standard criteria. Ukraine’s credit ratings were lowered further into non-investment grade or junk territory, preventing many major institutional investors from buying their debt as the invasion began.

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War bonds are controversial. They are by nature unpredictable because they are frequently sold during the most uncertain phases of a nation’s economic and political performance, even when it is on the verge of collapse. Increasingly, investors must be conscious of environmental, social, and governance standards when dealing with these events.

 

Ukraine’s war bonds allow investors to lend money directly to the country’s embattled government and potentially receive a significant return while doing so. Investors in the retail sector attempted to catch a piece of the action – this can be seen by reading investment forums on Reddit.

 

According to the finance ministry, this isn’t the last war bond sale. However, the primary question is whether Ukraine will issue short-term hard currency bonds, which would attract a far broader audience of foreign investors. The yield and the risk tolerance in place at the time of the auction will determine whether overseas investors participate.

 

On the other hand, Ukraine’s bonds are well positioned compared to their Russian rivals. Following the most recent sanctions, the Russian debt market has come to a complete halt. Most banks and dealers now only sell Russian bonds instead of global debt, resulting in overall demand depletion.

 

Emergency bonds aren’t just used in wartime: In 2020, Larry Kudlow, a senior economic adviser to President Trump, suggested selling debt with a structure comparable to wartime bonds to help the economy recover from the coronavirus epidemic. Finally, the stimulus package was paid for with Treasury bills.

 

During the pandemic, the EU considered selling what became known as ‘coronabonds’, a contentious risk-sharing instrument. However, the idea did not take off; therefore, the bloc’s 27 members have undertaken their biggest-ever borrowing in a single program known as the NextGenerationEU bond initiative.

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