Book 4_Fixed_READING 52_FIXED-INCOME MARKETS FOR CORPORATE ISSUERS Flashcards
Forms of short-term funding for nonfinancial corporations
- lines of credit (uncommitted, committed, and revolving in order of increasing reliability and cost),
- secured loans,
- factoring arrangements,
- and commercial paper issuance.
Revolving (operating) line of credit
- “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
A major form of short-term funding for financial institutions
Deposits from customers
Savings deposits
The form of certificates of deposit; which can be:
- nonnegotiable (no early withdrawal without penalty)
- or negotiable (can be sold to a third party)
Other sources of short-term financing for financial institutions
Interbank funds (including repos), central bank funds, and commercial paper (including asset-backed commercial paper).
A repurchase agreement
- 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
Repurchase price for repo
Price (loan amount) = market value of securities / initial margin
Hair cut = 1 - 1/initial margin
The main uses of repos
- 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).
The repo rate
- 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.
Repo risks
- 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.
Relative to investment-grade debt, high-yield debt is likely to
- 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
Sovereign issuers
are usually the highest credit quality and largest issuers of debt in any given bond market.
Developed market sovereign issuers
have stable, diversified economies with consistent and transparent fiscal policy, with debt denominated in a major reserve currency
Emerging market sovereign issuers
- 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)
Ricardian equivalence theory
- 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
Benefits of having a broad range of maturities of government securities
- 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
Agency or quasi-government bonds
are issued by entities created by national governments for specific purposes such as financing infrastructure investment or providing mortgage financing
Local and regional government authorities
may issue debt for general public spending backed by local tax raising powers (general obligation bonds) or to fund a specific project (revenue bonds)
Supranational bonds
are issued by international institutions that promote economic cooperation, trade, or economic growth.
Sovereign issuers
use regular public auctions to issue government debt securities.
Auctions bids
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.
In a single-price auction
all investors pay the price associated with the cut-off yield.
In a multiple-price auction
successful competitive bidders actually pay the price that they bid
Primary dealers
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
sovereign debt trading once issued
typically trades in quote-driven OTC dealer markets. Trading is most active and prices most informative for on-the-run bonds.
