Chapter 20 MARKETS FOR CORPORATE SENIOR INSTRUMENTS I

Chapter 20 MARKETS FOR CORPORATE SENIOR INSTRUMENTS: I

Corporate Debt Market z. Markets in which firms can borrow: y. Commercial Paper Market y. Medium-Term Note Market y. Euronote Market y. Bank Loan Market y. Bond Market (Chapter 21) zsince 1980 s, more borrowing directly from markets, fewer ‘bank loans’

Credit Risk z default Risk yissuer won’t make payments on time z credit spread: premium on gilt/sovereign ycredit spread risk: if premium increases, existing debt market value falls z how assess credit risk? ybig firms do in house yelse (US) commercial ratings: Moody’s, S&P, Fitch z downgrade Risk yrisk that credit quality of issuer declines.

Commercial Paper zshort-term unsecured promissory note (IOU) issued in the open market zbridge financing, seasonal, working zmaturity reflects SEC regulations: y<270 days doesn’t require registration y< 90 days allows use as collateral with Fed zroll over: pay off with new issue zmay back by unused bank credit lines zlittle secondary market activity

Issuers of Commercial Paper zlarge firms with strong credit quality zmostly financial companies (80% in 1997) ycaptive finance companies (to fin. parents) ybank-related finance companies yindependent finance companies z. LOC paper: backed by LOC (only use bank to back, not also to lend) zbanks moving into paper to recoup lending decline

Placement of Commercial Paper z. Direct Paper ydirectly placed by issuing firm to investors z. Dealer-Placed Paper yrequires service of an agent to sell the issuer’s paper ybest efforts underwriting (dealer doesn’t buy the issue)

Medium-Term Notes (MTN) zmaturities (9 mo- 30 yrs; 100 yrs Disney) in ranges zissued continuously by agent: ybuyer selects maturity from range yagent chooses spread to attract buyers y‘continuous’ unlike bond tranches zgrowth in last 20 yrs due to flexibility ztypically issued by non-financial corporations

MTNs II zrated by rating agencies zregistered with the SEC z. Placement and Distribution ysold on a best-efforts basis by an investment banker ysold in small amounts zminimum purchase usually $1 – 25 mn

Structured MTNs z‘structured’ = tailored z. Combine offering with positions in derivative markets to create debt obligations with more interesting risk/return features. zidea: spread, coupon can be functions of: yprice, stock market indices; exchange rates… yoften to hedge derivatives risk y 20 -30% of new issues

Bank Loans z‘Eurocurrency’ loans: any loan (in the US) by an offshore bank yeuroyen yeurodollar…

Syndicated Bank Loans z a group of banks provides funds to the borrower, spreading the risk z senior bank loans: senior to bondholders z rates usually floats relative to LIBOR, prime… z fixed term, collateralized z Marketable: members can sell shares (even in non-performing loans): yassignment: assignee becomes de facto owner yparticipation: participant relates to creditor & debtor

Lease Financing zusually for expensive equipment ylessor: buys equipment, leases to lessee ylessee: rents equipment ytherefore, splits ownership from use rights z. Leasing arrangements yleveraged lease (lessor borrows to buy) v. direct ytax-oriented: ownership tax breaks for lessor