Lesson 13: Debt Financing

Question 1

prospectus

Answer 1

describes the offering of the public debt securities that corporation issues

Question 2

indenture

Answer 2

a formal contract between the bon issuer and a trust company (represents bondholders) in indenture

Question 3

original issue discount

Answer 3

= face amount - sales price

Question 4

4 types of public debt

Answer 4

1. Notes: unsecured debt, term < 10
2. Debentures: unsecured debts, term >= 10
3. Mortgage bonds: debts secured = property
4. Asset-based bonds: Debts secured = assets other than real property

Question 5

Seniority

Answer 5

indicates which ones have priority over the assets

Question 6

Subordinated

Answer 6

Subordinated debts: debts that are junior to other debts

Question 7

4 types of international bonds

Answer 7

1. Domestic bonds: issued domestically in local currency, foreign investors may purchase it
2. Foreign bonds: issued locally = a foreign company, in local currency (Yankee bonds in US)
3. Eurobonds: not denominated in the currency of the country in which they are issued
4. Global bonds: combine feature of 1,2,3; sold in many countries simultaneously, each in its own currency

Question 8

2 types of private debt

Answer 8

1. term loans: loan from a bank/ a group of banks for a specific amount that has a specific repayment schedule, term loans are investment grade
2. Private placements: loan from a small group of investors, cheaper to issue than public debts (dont require prospectus, indenture)

Question 9

Sovereign debt

Answer 9

debt issued = national gov

Question 10

The US gov issues 4 types of debt

Answer 10

1. Treasury bills: term <= 1 year, issued at a discount, no coupons, face amount is paid at maturity
2. Treasury notes: 1 year < term <= 10 years, semi annual coupon
3. Treasury bonds: term > 10 year, semi-annual coupon
4. TIPS: Treasury inflation protected securities, fixed coupon rates, principal is adjusted with inflation, coupon = face amount (adjusted with inflation) * semi-annual coupon rate

Question 11

Selling treasury securities

Answer 11

sold = auction, competitive bids a price, non-competitive buys securities at that price, all successful competitive bids are fulfilled at lowest winning price / highest interest rate

Question 12

STRIPS

Answer 12

available on secondary market, are Treasury notes or bonds with coupons stripped

Question 13

Treasury bonds (tax)

Answer 13

exempt from state and local taxes, taxable on federal level

Question 14

Municipal bonds

Answer 14

issued = state and local gov, NOT taxable on federal level, states exempts them form its income tax, pay semiannual coupons, have floating/ fixed coupon

Question 15

3 types of municipal bonds

Answer 15

• General obligation bonds: backed = issuer credit worthiness, ability to levy taxes from its residents
• Revenue bonds: issued to fund public projects which then repay investors from the income created by that project
• Double-barred bond: backed = both a defined source of revenue (other than property taxes) and the full faith and credit or taxing power of the issuer

Question 16

Asset-based securities

Answer 16

pay interest and principal from cash flows generated = specific assets, largest sector: mortgage based securities

Question 17

Examples of government-sponsored enterprises offering mortgage based securities

Answer 17

• Government National Mortgage Association (GNMA or Ginnie Mae): guaranteed = US gov
• Federal National Mortgage Association (FNMA or Fannie Mae)
• Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac)

Question 18

Student Loan Marketing Association

Answer 18

• known as Sallie Mae, securities = student loans

Question 19

Risk of Sallie Mae, Fannie Mae, Freddie Mac

Answer 19

• not guaranteed by gov, but have implicit guarantee (investors believe that gov would nor allow them to default)
  ->little or no default risk
• have prepayment risk

Question 20

Collateralized debt (CDOs)

Answer 20

• debts from asset-based loans may be packed as collateralized debt obligations, these packages may be split into tranches with different priorities