Book 4_Fixed_READING 52_FIXED-INCOME MARKETS FOR CORPORATE ISSUERS

Question 1

Forms of short-term funding for nonfinancial corporations

Answer 1

• lines of credit (uncommitted, committed, and revolving in order of increasing reliability and cost),
• secured loans,
• factoring arrangements,
• and commercial paper issuance.

Question 2

Revolving (operating) line of credit

Answer 2

• “Revolvers” are typically for a longer term, sometimes years (with potential medium-term loan facilities).
• Banks typically place restrictive covenants on borrowers under such agreements.
• Fees and rates are similar to a committed line of credit

Question 3

A major form of short-term funding for financial institutions

Answer 3

Deposits from customers

Question 4

Savings deposits

Answer 4

The form of certificates of deposit; which can be:
- nonnegotiable (no early withdrawal without penalty)
- or negotiable (can be sold to a third party)

Question 5

Other sources of short-term financing for financial institutions

Answer 5

Interbank funds (including repos), central bank funds, and commercial paper (including asset-backed commercial paper).

Question 6

A repurchase agreement

Answer 6

• Is a collateralized loan whereby a borrower sells a security to a counterparty with a commitment to buy it back later at a higher price.
• The annualized percentage difference between the two prices represents the repo rate

Question 7

Repurchase price for repo

Answer 7

Price (loan amount) = market value of securities / initial margin
Hair cut = 1 - 1/initial margin

Question 8

The main uses of repos

Answer 8

• For borrowers to finance positions in securities,
• For lenders to earn the repo rate on excess liquidity,
• For central banks to engage in monetary policy,
• For short sellers to temporarily borrow securities (as the lending party in the repo).

Question 9

The repo rate

Answer 9

• will be higher for longer-term repos, lower quality collateral, or when the repo is undercollateralized.
• will be lower for a specific security that is difficult to source.

Question 10

Repo risks

Answer 10

• Default risk, collateral risk, margining risk, legal risk, and netting and settlement risk.
• The use of a tri-party repo can help mitigate these risks.

Question 11

Relative to investment-grade debt, high-yield debt is likely to

Answer 11

• have a higher proportion of its yield related to credit spread,
• a greater number of covenants,
• shorter maturity,
• and more equity-like returns,
• and is likelier to have call or prepayment provisions

Question 12

Sovereign issuers

Answer 12

are usually the highest credit quality and largest issuers of debt in any given bond market.

Question 13

Developed market sovereign issuers

Answer 13

have stable, diversified economies with consistent and transparent fiscal policy, with debt denominated in a major reserve currency

Question 14

Emerging market sovereign issuers

Answer 14

• Typically have faster growing, less stable, and more concentrated economies and, consequently, less stable tax revenues, sometimes tied to a dominant industry or commodity.
• Can be domestic (issued in domestic currency and held by domestic investors) or external (owed to foreign creditors)

Question 15

Ricardian equivalence theory

Answer 15

• suggests taxpayers expect that future taxes will have to repay any debt the government issues
• states that governments should be indifferent about raising taxes today or issuing debt of any maturity

Question 16

Benefits of having a broad range of maturities of government securities

Answer 16

• include the identification of benchmark government yield curves;
• the ability of investors to hedge interest rate risk;
• the ability to pledge the securities as collateral for repos;
• the ability of the central bank to use government bonds to execute monetary policy

Question 17

Agency or quasi-government bonds

Answer 17

are issued by entities created by national governments for specific purposes such as financing infrastructure investment or providing mortgage financing

Question 18

Local and regional government authorities

Answer 18

may issue debt for general public spending backed by local tax raising powers (general obligation bonds) or to fund a specific project (revenue bonds)

Question 19

Supranational bonds

Answer 19

are issued by international institutions that promote economic cooperation, trade, or economic growth.

Question 20

Sovereign issuers

Answer 20

use regular public auctions to issue government debt securities.

Question 21

Auctions bids

Answer 21

can be either competitive or noncompetitive.
- Competitive bids are used to set the price of the debt issue,
- While noncompetitive bids are guaranteed to have their allocation met at the auction price.

Question 22

In a single-price auction

Answer 22

all investors pay the price associated with the cut-off yield.

Question 23

In a multiple-price auction

Answer 23

successful competitive bidders actually pay the price that they bid

Question 24

Primary dealers

Answer 24

are financial institutions required to make competitive bids in auctions, submit bids in auctions on behalf of third parties, and act as counterparties to the central bank

Question 25

sovereign debt trading once issued

Answer 25

typically trades in quote-driven OTC dealer markets. Trading is most active and prices most informative for on-the-run bonds.