Annuity, Consols, Bonds and Federal funds
Stocks are by far not the only options to invest in. Annuity, consols, bonds and federal funds are investment options among several others. A Federal fund is, in simple language, an overnight short term(1–2 days) cash borrowing between banks to maintain the stipulated cash reserve. The banks lending the money charge an interest and this rate has in the past never been a trivial one, except for after the financial crisis of 2007–2008. After this, as banks went haywire borrowing from each other, the European Central Bank lowered the interest to facilitate such interactions and it was a result of this action that the rates crashed down to nearly zero and then even plunged into negative in the EONIA- European Overnight Index Average. Similarly, in the United States, the interest rates followed a parallel pattern, with the them too plunging to nearly zero in 2016. This trend, had however started reversing with the rates peaking at 2.5% in October 2018 but with the advent of the coronavirus, the Fed had to bring them down to nought. As to why the European rates went into negative, one of the explanations is that it had become costly for banks to store money for various reasons like space, theft insurance, transportation and other costs incurred for the upkeep, and it was way more convenient for the banks to just lend it out. Regarding the causes of interest rates, Eugen von Böhm-Bawerk has also stated that there were three principal reasons behind this: technical progress, time preferences and advantages to roundaboutness. This nevertheless is not of much relevance to people other than bankers because such overnight short term borrowings are only employed by banks or other wealthy professionals.
Bonds are long term debt contracts and fixed income securities, wherein governments or corporations sell ‘loans’, i.e., if a person bought a standard $100 bond, they would be entitled to a repayment of the amount after the maturity of this bond, apart from receiving bi-annual interest which can be availed through coupons that come with the bond. This functions like a loan, where the creditors(people who bought the bond) receive the interest(bi-annually) and the amount due to them after a stipulated maturity period of the bond. Such devices are employed by governments and corporations when they are in need of urgent funds for projects, expansion or even war. There is another type of bond called the discount bond, wherein the creditors do not receive such coupons or securities. The incentive here, as the name suggests is that the bonds are bought at a discounted rate, lower than the standard $100 and as the bond matures, the debtors are supposed to repay a sum of $100.
Consols are just like bonds. The difference here is, there is no maturity period and hence no principal repayment after a specified time period. These just keep going on and the coupons can, in principle be regularly redeemed till the end of time. Thus, as can be inferred, consols are only laid out by governments because they are much more stable and long lasting than any private corporations. But the catch here is that while the coupon is fixed at the time the bond is issued, the market price of the bond can change. This implies that if the government issued a￡3 consol for￡100 pounds and if the market price of this bond rose to￡200, then the yield to maturity would plummet to￡1.5 . Thus, even if there is no foreseeable default risk, consols are considered to be risky because of the impending market risk. Consols were first introduced by the British in the mid 18th century and they are still being paid out by the government.
Annuities are closer to consols than they are to bonds. The only difference between consols and annuities is that annuities do have to stop after a certain time, and the principal difference between an annuity and a bond is that there is no principal repayment at the termination of an annuity. Examples of annuity are home mortgages and EMIs. They are hence, periodic instalments to repay one’s debts.
