How do Israeli Bonds Work?

History of Israel Bonds

The State of Israel first initiated Israel Bonds in 1951. Since then, the country has issued bonds through its securities underwriter known as the Development Corporation for Israel (DCI). Initially, the government of Israel issued bonds to the Jewish community members who wanted to assist the country. These bonds were provided as plain vanilla “bullet bonds” . Later on, Israel established branches in Europe and Canada and diversified its products and services. In turn, this increased the diversification of its investor categories, such as insurance organizations, large banks, and U.S. local municipalities (Elo & Riddle, 2016). Although bonds have been found to increase the liquidity and borrowing power of the country, they also compromise the precarious security position of the country. This paper aims at exploring the nature of Israel bonds to identify whether they are suitable for investment.

Structure of Israel Bonds

According to Israel Bond International, an Israel Bond is considered to be a loan that a person can make to the Israeli State. The State utilizes the loaned money to assist in reinforcing all sections of its contemporary, creative and diverse economy. The bonds are supported by the full credit and faith of the Israel state, which has made interest and capital payments always since the Israel bond initiation . At its conception, Israel bonds only provided one security. As the program grew successfully, Israel increased the investment options including the Maccabee Issue Bonds, Jubilee Issue Bonds, Floating Rate LIBOR Bonds, eMitzvah Bonds and Mazel Tov Bonds. The rates of most bonds change twice each month. The rates of treasury bonds and spread determine the interest of fixed-rate bonds (Development Company for Israel Limited, 2018). Also, rates for floating rate bonds are the same as LIBOR rate for half a year in effect on the preliminary determination date, added or subtracted a spread that is fixed all through till maturity.

Israel Bonds compared to Non-Israel Bonds

Unlike other foreign nations’ bonds, Israeli government offices based in the United States sell the country’s bonds. This arrangement is beneficial because it helps to eliminating brokerage fees. The bonds pay interest and principal in US dollars, thus eliminating the risk of currency fluctuation that affect most international ventures (Development Company for Israel Limited, 2018). For these reasons, purchasing Israel bonds is analogous to a U.S. investor who buys U.S. Treasury securities directly from the Federal Reserve.

However, there is a big distinction as Israel bonds are guaranteed by the government of Israel and not the U.S. government (Elo & Riddle, 2016). Even though Israel has never defaulted on its debt obligations, the country’s credit worthiness is lower than that of the U.S. Another major factor to consider it that the market price of a U.S. government bond issuance is determined by demand via an auction after the Treasury announces the amount of the bonds that it intends to issue. Treasury executives first declare the coupon rate and then, based on the existing interest rates on the sale day, the bonds sell at a discount or premium to face value . The interest rate stays unchanged, thus those who purchase and keep treasuries relish a set produce to maturity (Development Company for Israel Limited, 2018). They are also liquid; a dynamic secondary market for treasuries implies that anyone can sell at any moment.

Investors’ attitudes toward Israel Bonds

Although Israel has never failed to pay principal or interest rates on any of its debts, potential buyers are warned of severe credit risk. Securities issued by sovereign countries utilize debt markets to generate capital to meet costs and venture in infrastructure. This implies that the bonds issued are debt instruments that offer increased payout upon maturity. Essentially, the holder of the bonds is loaning money to the sovereign in trade for high future payback. Therefore, sovereigns use the bond market as tools for the venture and even utilize bonds for debt service, implying that the bonds issued today are meant for paying the corresponding maturing bonds that were sold earlier (Elo & Riddle, 2016). Some investors have shown great interest in sovereign bonds by increasingly buying them despite the rise in global national debts, likely because of their liquidity. Rambarran and Ramlakhan (2014) state the liquidity of these bonds is because the investors who initially purchased the bonds can easily sell them on the secondary market before maturity. Therefore, investors have shown a disdainful perspective towards prospective sovereign default on those bonds.

Israel Equities: An excellent way to directly invest in the Country’s businesses

Investing in Israel equities involve buying shares of private companies anticipating that those companies will grow in value overtime in the form of capital gains and/or through dividends paid periodically to shareholders . Although volatile, equity investing will likely be a better approach for long-time investors seeking growth because the potential for increasing value of the invested principal amount is higher than those of investing in bonds . Another benefit of equity investing is that numerous options are available even for a small initial investment.

One factor investors should consider when deciding whether to invest in Israel bonds versus Israel equities is that of inflation. Fixed-rate bonds, whose coupon payment levels are fixed throughout the term of the bond, will be negatively affected by higher-than-expected inflation. While Israel’s inflation rate has actually been negative recently primarily due to the effects of COVID-19 on the economy , the inflation forecast for 2021 is closer to +1.5% and for 2020, up to +4.0%. With this potentially higher inflation looming on the horizon, Israel bond investors may find themselves losing much of their principal and income to inflation. Equities, on the other hand, can experience higher growth rates because they are not constrained by contractual income payments, and hence outpace inflation.

Furthermore, long-time investors may raise investments through preferred shares if their organizations wish to increase capital in equity markets. In this way, the investors will be able to the receive monetary difference if they trade their shares or if the assets of the organization get liquidated and meet all its obligations (Joshua, 2014). Thus, while Israel bonds can serve a wonderful purpose in the world, and are appropriate for some investors, for the vast majority of investors looking for a financial connection with Israel with upside, investing in Israel equities can be a better approach for many investors over time compared with investing in Israel Bonds.

With this said, there is no one-size-fits-all approach. Perhaps the best approach for an investor may be to utilize both Equities and Bonds by determining a holistic asset allocation appropriate for that person’s long-term investment objectives and taking into account factors such as risk tolerance and portfolio time horizon.

 

 

References

Development Company for Israel Limited. (2018, September 6). State of Israel Bond Issuance Programme. Retrieved from https://www.israelbondsintl.com/lang-pdf/Information-Memorandum%20-%20Sept%202018.PDF

Elo, M., & Riddle, L. (2016). Understanding diaspora investment. In Diaspora business (pp. 13-28). Brill.
Israel Bond Intl. (2020). What is an Israel Bond? Retrieved from https://israelbondsintl.com/

Rambarran, J., & Ramlakhan, P. (2014). Diaspora Bonds and Caribbean Economic Development. In Global Diasporas and Development (pp. 105-120). Springer, New Delhi.
Joshua K. (2014). Investing In Israel: The Impact of Geopolitical Risk. Retrieved from https://bluestarindexes.com/wp-content/uploads/2016/03/Investing-in-Israel-The-Impact-of-Geopolitical-Risk-Sept-2014.pdf (Accessed 2020, September 21)