Module 11 Flashcards
Money markets
Enable organisations to manage working capital efficiently, grown significantly recently due to disintermediation
Interbank loan (investor/ borrower)
Investor = Lend Borrower = Borrow
Certificate of deposit (investor/ borrower)
Investor = Buy Borrower = Issue
Government bonds (investor/ borrower)
Investor = Buy Borrower = Issue
Commercial paper (investor/ borrower)
Investor = Buy Borrower = Issue
Repurchase agreement (investor/ borrower)
Investor = Invest in Borrower = Borrow through
Money market funds (investor/ borrower)
Investor = Invest in Borrower = Borrow through
Interbank loans (4)
- Loans extended from one bank to another
- Most short term to meet regulatory reserve requirements
- Banks offer short-term loans at LIBOR
- LIBOR being phased out to be replaced with SONIA
Certificate of deposit
Deposit with specific maturity, evidenced by a certificate. Large denomination CDs are typically negotiable (can be traded)
Floating rate certificate of deposits
Similar in form to ordinary CD but dealt with in same manner as floating rate notes. The rate of interest is set at pre-determined spread about LIBOR
Government bonds (4)
- Maturity of one year or less
- Safest possible investment
- Issued at discount
- Redeemable at par with no interest payable
Commercial paper (5)
- Short-term debt obligation (usually maturity < 9 months)
- Typically unsecured
- Common for issuers to roll over paper (use proceeds of issue to repay principle of previous issue)
- Only corporations with strong reputation can successfully issue commercial papers
- Can be issued in international markets
Repurchase agreements (repos) (4)
- Combination of two transactions > sale and repurchase
- First transaction > bank sells securities to investor agreeing to repurchase securities at specified higher price at a future date
- Second transaction > repo is unwound as bank buys back securities from investor
- Amount investor lends is less than value of securities to ensure it has sufficient collateral
Money Market funds
Standalone, pooled investment fund which actively invests its assets in diversified portfolio of high grade, short term money market instruments
When trade occurs
One or both parties reports the event electronically to the clearing house. Clearing house settles the transaction by debiting the account of one party and crediting the account of another.
UK Money markets Voluntary code of conduct - key principle
Participants should promote integrity and effective functioning of markets
Three main sources of long term finance catered for in the capital markets include
- Long term finance
- Equity
- Bonds (government/ corporate)
Long term government bonds
Repayable in more than a year at the time of issue and are usually interest bearing - generally issued at face value with interest being paid on the initial amount
Long term Corporate bonds
Debt issued by businesses in tradeable form
Bondholder can protect their investment using two principle means
- Covenants
- Security (fixed or floating charge)
Two forms bonds can be issued in
- Registered
- Bearer
Registered
Ownership is recorded by issuer
Bearer
Ownership is not recorded by issuer
Coupon (payments) made on bond made on
Annual or semi-annual basis
Final payment of bond includes
Principal repayment
Coupon rate
Interest payments on the bond stated as a percentage of the face value to be paid each period
Face value (par value)
Amount the issuer has agreed to repay on maturity. Redemption can be made at either discount to, or premium on
Maturity date
Date of final payment
Sinking funds
Provide partial repayment of principal at regular intervals, usually yearly
Yield of a bond =
Measure of the return to the bondholder on their investment
Interest yield on a bond (flat yield)
Nominal annual interest / Market price
Redemption yield (yield to maturity)
Takes into account the capital repayment on maturity as well as regular interest payments. Calculation of redemption yield is IRR calculation
Negative yield
Pay more for bond than you will get back over the life of the asset.
Can be popular if negative bond yield is less than charge on cash balances from banks
Borrowing by issuing bonds > advantages (5)
- Funding diversification
- Covenants (less onerous than other debt instruments)
- Speed
- Currency (can be issued in many different currencies)
- Flexibility (can be tailored to meet needs of business and investor)
Straight bonds
Conventional fixed-rate bond with series of annual or semi-annual coupons and may have optional redemption provisions prior to maturity
Zero coupon bonds
Pays single fixed amount at maturity. No interest payments.
Deep discount bonds
Pays low annual coupon but bonds are issued at discount to par value
Partly paid bonds
Only portion (15-30%) paid on issue, balance payable at later date - usually after 6-9 months
Index-linked bonds
Redemption value and interest payments adjusted to take account of increases in appropriate price index over life of the bonds eg RPI in UK
Dual currency bonds
Gives the holder the right to redemption in one of other of two currencies at fixed rate of exchange
Convertible bonds
Can be converted (at investor’s option) into given number of ordinary shares.
Bonds with equity warrants
Equity warrant entitles holder to purchase pre-determined number of ordinary shares at pre-determined price on or by date.
FRNs (floating rate notes)
Bonds with fixed maturity, where interest coupon is regularly adjusted, fixed with reference to LIBOR usually for 3 or 6 months
Two types of embedded options
- Call option
- Put option
Call option
Allows the issuer to buy back the bond at par
Put option
Allows the holder to sell the bond back to the issuer at a particular price (eg if interest rates rise and bond price falls)
Global bond market is comprised of (3)
- Domestic bonds
- Foreign bonds
- Eurobonds
Domestic bonds =
Bonds issued by companies in their own country and in own currency
Foreign bond markets =
Bonds issued within the domestic market of the currency of denomination, but issued by non resident borrowers eg Yankee/ Bulldog
Eurobond market =
Bond denominated in currency which differs from that of country of issue
Considerations when deciding where and how to raise capital (4)
- Which market has cheaper cost of borrowing
- Where they can issue to diversify investor base
- Currency most suited to their needs
- Regulations subject to by issuing in a certain country
Usual method of issue of domestic UK corporate bonds is by a
Bought deal
Bought deal =
One or more lead managers commit to purchase or underwrite the entire issue. Issue is bought either at a fixed price (immediate certainty of cost) or on a yield margin relative to a benchmark, gilt-edged stock (exposed to gilt market movements)
Grey market trading
Unofficial dealing on a ‘when issued’ basis - indicated the price at which the bonds will trade when officially listed
Majority of Eurobond issues are launched using the
Placing mechanism
Placing mechanism
Lead manager (bank) makes firm offer to issuer, specifying the structure of issue and all-in cost. Acceptance of issuer forms binding contract, authorising launch of bond on agreed terms. Lead manager then invites banks/ investors to buy. Lead is responsible for underwriting the issue and will TRY to obtain best price for issuer (unlike brought where price is agreed at the start)
Private placement
Bonds sold to private investors eg banks/ pension funds. Reduces regulation and speeds up issuing process. Applies to both UK Domestic and Eurobond.
Factors affecting pricing of bond issues (5)
- Government yield
- Credit rating
- Pricing of comparable issues
- Size and liquidity of the issue
- The terms
Negotiability of bonds
After bond has been issued, may be traded on secondary bond market
Price of an irredeemable bond
Nominal annual interest / Market discount rate(or redemption yield
Nominal annual interest =
Coupon rate x nominal bond value
Expenses of bond issue (5)
- Professional advisors’ fees
- Printing costs
- Commissions
- Stock exchange listing charges
- Trustee’s fees
Credit ratings (6)
- Issuer of security can pay credit rating agency to evaluate the credit risk.
- Used by potential investors who are unfamiliar with issuer.
- Essential in some markets, unnecessary in others
- Rating applies to individual security not issuer
- Rating signifies likelihood of default
- Long term/ short term ratings
Rating criteria (6)
- Economic environment
- Financial structure
- Forecasts, budgets and contingency plans
- Quality of management
- Firm’s competitive position in the industry
- The industry
Triple A =
Best rating
Medium term notes (MTNs)
Another form of corporate debt financing > debt securities with maturities falling between those of commercial paper and corporate bonds.
Registered just like corporate bonds but cheaper and easier to register.
Offer of MTNs
Offered on a continuous or periodic basis (similar to commercial paper)
MTN features (3)
- Usually coupon-bearing instruments
- Not discount instruments
- Usually unsecured
Investing in short term vs long term
Balance of risk and return likely to be higher priority and liquidity a lower priority in long term (opposite for short term)
Green bond
Bond to raise funds for new and existing projects with environmental benefits
Green bonds criteria (4)
- Use of proceeds
- Process for project evaluation and selection
- Management of proceeds
- Reporting
