Part 13. Fixed-Income Markets: Issuance, Trading and Funding Flashcards
Global bond markets characteristics:
- Types of issuer
- largest issuers in developed markets are financial corporations and governments.
- emerging markets, nonfinancial corporations
- Credit quality
- S&P & Fitch - highest rating AAA, AA, A and BBB - investment grade bonds
- Moody’s – Aaa to Baa3, with B+ or lower are high yield, speculative junk bonds
- Original maturities
- money market - 1yr maturity or less e.g. T-Bills, commercial paper, negotiable certificates, CDs.
- capital market - securities with original maturities > 1 yr.
- Coupon structure
- floating or fixed rat dependent on coupon interest payments in indenture or reference rate over life of bond.
- floating attractive to institutions with liabilities, such as banks to avoid balance sheet effects of IR increase.
- Currency denomination
- bond price and returns determined by IR in bond currency, with majority issued denominated in US dollars or euros. - Geography
- domestic, foreign, eurobonds
- developed markets or emerging markets
- Indexing
- inflation linked bonds issued by gov/corporations of high credit quality. - Tax status
- issuers may issue bonds exempt from income tax.
- US - bonds can be issued by municipalities and are called municipal bonds,
Interbank money market
The rates are based on expected rates for unsecured loans from one bank to another.
The average calculated from survey of 18 banks expected borrowing rates in interbank market, after excluding highest and lowest quotes.
Floating rate = the reference rate must match frequency with which coupon rate on bond is reset, e.g. bond denominated in euros with coupon rate reset twice each year might use 6 month euro LIBOR or Euribor as reference rate.
Bond issues
Primary market = sales of newly issued bonds
Public offering = newly issued bonds can be registered with securities regulators for sale to the public
Private placement = newly issued bonds can be registered with securities regulators for sale to only qualified investors.
Steps of public offering
- Determining funding needs
- Structuring debt security
- Creating bond indenture
- Naming bond trustee
- Registering issue with securities regulator
- Assessing demand and pricing bonds given market conditions
- Selling bonds
Selling bonds
This can be done by:
- Underwritten offering = the entire bond issue is purchased from issuing firm by investment bank (underwriter).
- smaller bond issues may be sold by single investment bank for larger issues, the lead underwriter heads syndicate of IB who collectively establish pricing of issue and selling bonds to dealers who sell to investors.
- syndicate takes risk bonds will not be sold.
Grey market = a new bond issue is publicised and dealers indicate their interest buying binds, provides info about appropriate pricing, with some traded on when issued basis.
- trading prior offer date of bonds provides additional info about demand and market clearing price of new bond issue.
2. Best efforts offering = IB sell bonds on commission basis, and do not commit to purchase the whole issue. - US Treasury securities sold through single price auction with majority made by primary dealer and Fed facilitating the open market operation.
- shelf registration = bond issue registered with securities regulators in its aggregate value with master prospectus, and require less disclosure, but only financially sound companies are offered this option.
Secondary markets
The trading of previously issued bonds, while some traded on exchanges, the majority is made in the dealer or OTC market.
- dealer post bid (purchase) prices and ask or offer (selling) prices for various bond issues, and its difference in bid and ask price is dealers spread.
- average spread is between 10 and 12 bp, but varies according to liquidity.
- settlement of gov bond is on the day or t+1.
- settlement of corporate bond is on t+2 or t+3 or longer
Sovereign bonds
- national gov or their treasuries issue bonds backed by taxing power of the government.
- issued in currency of issuing government carry high credit ratings and considered to be free of default risk from ability to collect taxes and print currency support.
- credit rating higher for local currency bonds than euro or US, as national gov cannot print developed market currency and local tax collections are dependent on ER between 2 currencies.
on-the-run/benchmark bonds = trading is most active and prices most informative for most recently issued gov. securities of particular maturity, as yields of other bonds determined relative to benchmark yields of sovereign bonds of similar maturities.
- issue fixed rate, floating rate, inflation-indexed bonds
Non-sovereign gov bonds
- Issued by states, provinces, counties, and sometimes entities created to fund and provide services such as for construction of hospitals etc.
- payments of bonds are supported by revenues of specific project, from general tax revenues or special taxes or fess dedicated to repayment of project debt.
- typically high credit quality, trade higher yields than sovereign as credit risk is perceived to be more.
Agency/Quasi government bonds
- issued by entities created by national governments for specific purpose such as financing small businesses or providing mortgage financing.
US issues by GSEs such as Federal National Mortgage Association.
- some are backed/or not by national gov. give them high credit quality, but yields are marginally higher than those of sovereign bonds.
Supranational bonds
- issued by agencies, such as multilateral agencies.
e. g. World Bank, IMF, Asian Development Bank - typically have high credit quality, very liquid especially large issues of well-known entities.
Bilateral loan vs syndicate loan
- Bilateral loan = when corporations fund their businesses to some extent with bank loans, typically LIBOR-based (variable rate loans), when loan involves only one bank.
- Syndicate loan = when loan is funded is funded by several banks
Commercial paper
- For larger creditworthy corporations, funding costs can be reduced by issuing ST, unsecured debt securities.
- for these firms interest cost of commercial paper < interest on bank loan.
- yields > ST sovereign debt as has on average more credit risk and less liquidity.
bridging finance = used to fund working capital and as temporary source of funds prior issuing LT debt; until permanent financing can be secured.
Rollover risk
= CP is often reissued or rolled over when it matures, with risk company will not be able to sell new CP to replace maturing paper.
circumstances where co. will face rollover difficulties:
- deterioration in company’s actual or perceived ability to repay debt at maturity, increasing the required yield on paper or less-than-full subscription to new issue.
- significant systematic financial distress (i.e. 2008 financial crisis) that may freeze debt markets so little CP can be sold at all.
Backup lines of credit (liquidity enhancement)
- to get acceptable credit rating from the ratings services on their CP, banks agrees to provide the funds when the paper matures, if needed, except in case of material adverse change (i.e. when company’s financial situation has deteriorated significantly.)
Characteristics of commercial paper:
- typically issued as pure discount security, making single payment equal to face value at maturity.
- price is quoted as percentage discount from face value
- in contrast ECP rates may be quoted as either a discount yield or addon yield, that is % interest paid at maturity in addition to par value of commercial paper.
e. g. consider 240 day CP with holding period yield of 1.35%, if quoted with discount yield, it will be issued at 100/1.0135 = 98.668, and pay 100 at maturity. - if quoted with add-on yield, it will be issued at 100 and pay 101.35 at maturity.
