kscans

Chapter 225 - Episode 18: Middle Chapter. Convertible Bonds

"We will raise all the necessary funds with bonds."

As I said this, I glanced at the faces of the two men who control the kingdom's finances. Grynisias’s expression remained unchanged, but an unconcealable sneer surfaced on Volker’s face.

"Bonds are debt. We have, of course, considered supplementing our funds with loans. But this amount is out of the question. How will you make the interest payments, and how many years will it take to redeem them."

Even when providing funds to the state, the difference between a loan and a tax is whether or not the money is returned later. "Lend us what we lack" is met with far less resistance than "Give us what we need." But that has its limits. If you cannot pay it back, if you default, it amounts to the same thing. Funding for a military base to confront a horde of powerful monsters in a barren land is the worst kind of investment. Military spending is fundamentally an expense that yields no returns. However, this time is different.

"No, this is not a debt. It's an asset. And as for the interest. I plan to design a significant portion of these bonds in a way that requires neither interest payments nor redemption."

"This is absurd. Lord Chancellor, how long do you intend to listen to this nonsense."

Volker was now looking at me as if I were a complete fraud. Grynisias watched me with a probing gaze. Had my superior not been present, I might have been sent straight to a dungeon.

"What do you mean, it is an asset."

Euphillia let out a sigh. Then, she posed the question to me. I have already explained it, but... ah, perhaps I was moving too quickly.

"Allow me to explain. The funds raised through these bonds will not simply be squandered. Something will remain as a result. That something is the prototype of a new city which will become a future hub of trade with the Empire. This constitutes a newly created asset for the kingdom."

War expenditures are typically just consumption, but this case is different. It is closer to a construction bond than a war bond.

"I understand a new city will be built. But that is no reason for a debt to simply vanish."

In place of Volker, who was silently glaring at me, Grynisias spoke.

"We will add a special feature to the bonds we issue. Namely, a clause allowing the holder of these bonds to exchange them for securities representing a divided share of the rights to the new city, for Stocks, if they so choose."

The idea is based on convertible corporate bonds. In a sense, it is a debt for equity swap, an exchange of debt and capital. The bondholder becomes an investor in the city. In other words, if the bond purchaser wishes, the principal will become the city's capital, and the interest will become dividends.

"Those who wish to hold onto them as bonds will receive interest. Their principal will be returned upon redemption. This is the same as a regular loan. However, we will introduce a small innovation there as well, so first, let me explain them as simple bonds."

I looked at Mia. Mia stood up. She presented a sheet of paper she was holding to the attendees. The number 100 and a picture of a gold coin were drawn at the top.

"Please look at the sample bond we have distributed as a reference."

Mia said. Everyone turned over their papers.

"As for what is written. One hundred gold coins is the face value per bond. We will issue these bonds for eighty three gold coins, with a redemption period of ten years."

Mia said.

"We already need a colossal amount of funding, yet you propose selling one hundred gold coins for eighty three."

"Yes, and in exchange, there will be zero annual interest payments."

As a type of bond, it is what you would call a Zero-Coupon Bond. Instead of earning interest, it is sold at a discount from the very beginning. This, incidentally, was Mia’s idea. I only explained the concept of Discounted Present Value to her, and she apparently came up with it herself. Frightening.

"You mean the interest is discounted from the start."

This is already a new endeavor. This format is best for clarifying its value. Although, there is another major objective.

"What is the basis for the eighty three to one hundred ratio."

"Discounted Present Value."

Mia presented a new sheet of paper. It showed calculations for how much a value should be one year ago, two years ago, and so on, up to ten years ago, assuming a compound interest of a certain percentage.

"Discounted Present Value."

"Simply put, it means that one hundred gold coins received now have a different value from one hundred gold coins received ten years from now. This chart shows just how different that value is."

In response to Mia's answer, even the group of merchants, who should have already been briefed, were poring over the paper. Well, I suppose that cannot be helped. In this world, the meaning of interest is largely insurance against risk.

After all, the value of currency depends on the precious metals it is made from. Gold does not degrade, so there is no inflation in the sense of paper money losing value over time. Of course, there is the concept of opportunity cost. But with the economic growth rate here, it is almost meaningless. The Vinder Company is an exception, though.

"Let us assume an annual interest rate of five percent. What would be the value of one hundred gold coins received today one year from now."

Mia asked Volker.

"I see. If I lend out the one hundred gold coins I receive, it will become one hundred and five coins in a year. So, one hundred gold coins today is equivalent to one hundred and five gold coins one year from now."

Volker replied. He understands quickly. When I heard this in class in my past life, I remember how tangled my thoughts became. Financial concepts are fundamentally counterintuitive. That is why experts command high salaries.

"Yes, and conversely, one hundred gold coins one year from now is equivalent to 95.2 gold coins today."

"I see, so that is the logic behind selling a one hundred gold coin bond for eighty three."

"It eliminates the need for yearly interest payments, which simplifies management. In reality, applying that same calculation with a two percent interest rate compounded over ten years results in eighty two coins. We issue a bond that will be redeemed for one hundred gold coins in ten years for eighty three gold coins based on that calculation. The extra one gold coin is a management fee."

Mia continued her explanation. Incidentally, the two percent is, of course, a wartime interest rate. It is far removed from the actual risk, but that is based on the emergency logic that if we are destroyed, it is all over anyway.

Everyone struggled to somehow make sense of Mia's dispassionate explanation.

"I understand the meaning of the bonds. But redemption is ten years away. How will you secure credibility."

"That is the biggest problem. First, we will have His Majesty the King purchase a large quantity of these bonds."

Mia said.

"Due to the recent measures against the calamities and the victory against the Empire, the popularity of His Majesty the King, His Highness the Crown Prince, and Her Highness Princess Alfina is immense. This means the royal family possesses enormous credibility with the nobility and the common people. The royal family investing in these bonds means the royal family's credibility will be imparted to the bonds."

Mia's choice of words was harsh. Popularity had somehow become credibility. Well, this method makes the most of the King's declaration to offer up the royal family's assets to deal with the recent calamities. It is a way to scrape together money. As a citizen, my duty is to maximize the utility function of the King's sincere feelings for his country. Well, let us set aside the pretenses.

In my previous life, too, the greatest credibility belonged to the state. Bonds issued by the state, government bonds, had the most credibility and could get by with low interest rates. As a result, they became the benchmark for interest rates.

"Incidentally, I also intend to invest the majority of my assets in these bonds. As will Princess Alfina, of course."

Euphillia said.

"In that case, the nobles will have no choice but to contribute their funds as well. The funds will be gathered. But with such a massive amount, and a twenty percent premium at that, redemption in ten years is impossible."

"Yes, given the kingdom's current financial situation, redemption would likely take at least thirty years."

A figure that made one wonder how she knew such a thing came from Mia’s mouth. When I consulted with her about these bonds, she was using these sorts of numbers as a basis for her calculations without much thought. What did you do during your visits to the Chancellor's Office for things like standardizing transport regulations.

"Therefore, we will not pay it back."

"What did you say."

Volker’s eyes widened at the words Mia uttered so casually.

"As my senpai, Ricardo, said earlier, the collected funds will be transformed into an asset called a city. We will establish the right to receive a share of the profits from this city annually as dividends in the form of city Stocks. Regarding the Stocks, please confirm with Her Grace Grand Duchess Bertold."

Mia looked at the master of the house where she was staying.

"The Chancellor and the Minister of Finance should know well. You both seem to have a keen interest in my household's income."

Euphillia grinned.

"We will attach a condition to the bonds allowing them to be exchanged for shares of this new city's stock, according to their face value. In other words, one can choose to hold them as bonds to be redeemed in ten years, prioritizing safety. Or one can choose to exchange them for rights to the new city. The portion exchanged for stocks in the new city is no longer debt, so there is no need for redemption."

The exchange rate will probably be something like one hundred gold coins in face value for eighty two gold coins worth of city stock. Since it is a Zero-Coupon Bond, there are no interest payments up to that point.

"So, this scrap of paper will become gold coins."

"Yes, for example, a royal charter, or something like a guild license. These things also hold immense economic value in practice, do they not. It is a similar concept."

Mia said something that would make both merchants and nobles grimace. But no one rebuked her.

Now, the next problem is...

"A city to be built on what is now an empty plain. A monster's domain. Is it not possible that no one will convert to these so called Stocks."

Grynisias said. Exactly, if no one converts to stocks, it remains just a bond.

"We are considering the conversion period to begin in five years. The city's construction will advance rapidly through the coming war with the Magic Insects. The vast exchange of goods between the kingdom and the Empire is also guaranteed. With this as a backdrop, the city's value will become apparent to many people. Especially to the commercial world, which we assume will be the main purchasers of the bonds."

The merchants all nodded at Mia’s words. Now, for the political side. Grynisias fell silent in thought. He whispered something in Volker’s ear. Volker, with a deeply soured face, reluctantly nodded.

"There is one more concern. The disruption to the kingdom's economy from such a massive movement of funds."

The final problem has been raised. This grand project will distort the distribution of gold in the kingdom. Although it cannot be compared to the calamities, it will be a disaster for everyone. Especially for us merchants.