Chapter 20

MARKETS FOR CORPORATE SENIOR

INSTRUMENTS: I

Corporate Debt Market

Markets in which firms can borrow: Commercial Paper Market Medium-Term Note Market Euronote Market Bank Loan Market Bond Market (Chapter 21)

since 1980s, more borrowing directly from markets, fewer ‘bank loans’

Credit Risk

default Risk issuer won’t make payments on time

credit spread: premium on gilt/sovereign credit spread risk: if premium increases,

existing debt market value fallshow assess credit risk?

big firms do in house else (US) commercial ratings: Moody’s, S&P,

Fitchdowngrade Risk

risk that credit quality of issuer declines.

Commercial Paper

short-term unsecured promissory note (IOU) issued in the open market

bridge financing, seasonal, workingmaturity reflects SEC regulations:

<270 days doesn’t require registration < 90 days allows use as collateral with Fed

roll over: pay off with new issuemay back by unused bank credit lineslittle secondary market activity

Issuers of Commercial Paper

large firms with strong credit qualitymostly financial companies (80% in 1997)

captive finance companies (to fin. parents) bank-related finance companies independent finance companies

LOC paper: backed by LOC (only use bank to back, not also to lend)

banks moving into paper to recoup lending decline

Placement of Commercial Paper

Direct Paper directly placed by issuing firm to

investorsDealer-Placed Paper

requires service of an agent to sell the issuer’s paper

best efforts underwriting (dealer doesn’t buy the issue)

Medium-Term Notes (MTN)

maturities (9 mo- 30 yrs; 100 yrs Disney) in ranges

issued continuously by agent: buyer selects maturity from range agent chooses spread to attract buyers ‘continuous’ unlike bond tranches

growth in last 20 yrs due to flexibilitytypically issued by non-financial

corporations

MTNs II

rated by rating agenciesregistered with the SECPlacement and Distribution

sold on a best-efforts basis by an investment banker

sold in small amountsminimum purchase usually $1 –

25mn

Structured MTNs

‘structured’ = tailoredCombine offering with positions in

derivative markets to create debt obligations with more interesting risk/return features.

idea: spread, coupon can be functions of: price, stock market indices; exchange

rates… often to hedge derivatives risk 20-30% of new issues

Bank Loans

‘Eurocurrency’ loans: any loan (in the US) by an offshore bank euroyen eurodollar…

Syndicated Bank Loans

a group of banks provides funds to the borrower, spreading the risk

senior bank loans: senior to bondholders rates usually floats relative to LIBOR, prime…fixed term, collateralizedMarketable: members can sell shares (even

in non-performing loans): assignment: assignee becomes de facto owner participation: participant relates to creditor &

debtor

Lease Financing

usually for expensive equipment lessor: buys equipment, leases to lessee lessee: rents equipment therefore, splits ownership from use rights

Leasing arrangements leveraged lease (lessor borrows to buy) v.

direct tax-oriented: ownership tax breaks for

lessor