Lesson 13: Debt Financing

Question 1

Name the four types of public debt

Answer 1

1. Notes
2. Debentures
3. Mortgage bonds
4. Asset-based bonds

Question 2

What is a Note?

Answer 2

Unsecured debts with terms of less than 10 years typically.

Question 3

What are Debentures?

Answer 3

Unsecured debts, typically with terms of 10 years or more.

Question 4

What are Mortgage bonds?

Answer 4

Debts secured by real property.

Question 5

What are Asset-based bonds?

Answer 5

Debts secured by assets other than real property.

Question 6

What is seniority?

Answer 6

Seniority for notes and debentures indicates which ones have priority over the the assets. Most debentures restrict the company from issuing new debt with equal or higher priority over them.

Question 7

What are the four types of international bonds?

Answer 7

1. Domestic bonds
2. Foreign bonds
3. Eurobonds
4. Global bonds

Question 8

What are domestic bonds?

Answer 8

Issued domestically in local currency, but foreign investors may purchase it.

Question 9

What are foreign bonds?

Answer 9

Issued locally by a foreign company and sold locally in local currency. In the U.S. they are know as yankee bonds.

Question 10

What are Eurobonds?

Answer 10

Not denominated in the currency of the country in which they are issued.

Question 11

What are global bonds?

Answer 11

Combine features of domestic bonds, foreign bonds, and Eurobonds; they are sold in many countries simultaneously, each in its own currency.

Question 12

What are the two types of private debt?

Answer 12

1. Term loans

2. Private placements

Question 13

What are term loans?

Answer 13

Loans by a bank or a group of banks. Usually these are investment grade. A revolving line of credit allows a company to borrow up to a specific limit, as needed, for a specific time period.

Question 14

What are private placements?

Answer 14

Loans made by a small group of investors. These are cheaper to issue than public debt since they don’t require a formal prospectus or indenture, but they are not liquid, unlike public debt. However, SEC rule 144A allows trading of this sort of debt deterrent large financial institutions.

Question 15

What is sovereign debt?

Answer 15

Debt issued by national governments.

Question 16

What are the four types of debt issued by the U.S. government?

Answer 16

1. Treasury bills
2. Treasury notes
3. Treasury bonds
4. TIPS

Question 17

What are treasury bills?

Answer 17

Terms of 1 year or less and are issued at a discount. Currently they are available for 4, 13, 26, and 52 weeks. They have no coupons; the face amount is paid at maturity.

Question 18

What are treasury notes?

Answer 18

Terms of over 1 year but no more than 10 years. They have semi-annual coupons. Currently they are available for 2, 3, 5, 7, and 10 years.

Question 19

What are treasury bonds?

Answer 19

Terms greater than 10 years. Currently the only term issued is 30 years. They have semi-annual coupons.

Question 20

What are TIPS?

Answer 20

Treasury inflation protected securities, have fixed coupon rates but the principal is adjusted with inflation. The coupon equals the adjusted principal times the semi-annual coupon rate. The maturity value is the higher of the original face amount and the inflation-adjusted face amount. They are issued for 5, 10, and 30 years.

Question 21

How are treasury securities sold?

Answer 21

By auction. Competitive bids specify a price; non-competitive bids buy the securities at the price that the competitive bids settle for. All successful competitive bids are fulfilled at the lowest price (for bills) or highest interest rate (for other securities) that is accepted.

Question 22

What are STRIPS?

Answer 22

Treasury notes or bonds with coupons stripped; they are effectively zero-coupon binds. Interest-only is also available. Available on the secondary market.

Question 23

How are treasury bonds taxed?

Answer 23

exempt from state and local taxes but are taxed on the federal level.

Question 24

What are municipal bonds?

Answer 24

Issued by state and local governments. They are not taxable on the federal level, and usually the issuing state exempts them from its income tax.

Question 25

What are general obligation binds?

Answer 25

Payable from the full faith and credit of the issuer.

Question 26

What are revenue bonds?

Answer 26

Payable only from specific revenue sources; for example, if a revenue bond funds an expressway, interest and principal may only be payable from tolls collected.

Question 27

What is a double barreled bond?

Answer 27

A general obligation bond with a provision to set aside a particular revenue source to pay its principal and interest.

Question 28

What are asset-based securities?

Answer 28

Pay interest and principal from cash flows generated by specific assets.

Question 29

What are mortgage backed securities?

Answer 29

Pay cash flows from proceeds on a portfolio of mortgages. The largest escort of the asset-based securities.

Question 30

What are examples of government sponsored enterprises offering mortgage backed securities?

Answer 30

Ginnie Mae

Fannie Mae

Freddie Mac

Question 31

What is Ginnie Mae?

Answer 31

Government National Mortgage Association GNMA. These securities are guaranteed by the U.S. government.

Question 32

What is Fannie Mae?

Answer 32

Federal National Mortgage Association (FNMA)

Question 33

What is Freddie Mac?

Answer 33

Federal Home Loan Mortgage Corporation (FHLMC)

Question 34

What is Sallie Mae?

Answer 34

The Student Loan Marketing Association.

Question 35

What do Fannie Mae, Freddie Mac, and Sallie Mae have in common?

Answer 35

Though they do not have explicit government guarantees, investors believe the government would not allow them to default, so they have an implicit guarantee. They do have prepayment risk.

Question 36

What are collateralized debt obligations?

Answer 36

CDOs are debts from asset based loans packaged together.