Transcript FINANCIAL INTERMEDIARIES AND FINANCIAL INNOVATION

Chapter 21
MARKETS FOR
CORPORATE
SENIOR
INSTRUMENTS: II
Corporate Senior
Instruments
Corporate Bonds
Classified by type of issuer: ‘industrials’ >
banks/finance companies > utilities
Investors: life insurance companies, pension
funds (mostly institutional)
Preferred Stock
Basic Features of
Corporate Bonds: I
issuer promises:
coupon payments on designated dates
repayment of par/principal/face value of the bond at
maturity
failure to pay constitutes default
‘trustee’ responsible for ensuring compliance
with complex terms of each issue
bondholders have prior claim to both income
and assets of corporation
Basic Features of
Corporate Bonds: II
maturity of bonds
often 20-30 years
may exist provisions for early repayment
security for bonds
backed, not just rated
mortgage: creditor gets lien on pledged real assets
collateral trust: as above, but financial assets
debenture: unsecured beyond general right to any
unpledged assets
guaranteed: insurance issued by 3rd party
better backed  lower spread
Basic Features of
Corporate Bonds: III
retirement provisions
sinking fund: retire a proportion each year via trustee
to lower credit risk
do issuers have the right/option to retire
prematurely?
usually:
refunding restriction – cannot for 5-10 yrs with greater
seniority, lower interest
callable at premium above par: premium declines with time
‘call protection’ stricter: cannot redeem early ever
call/timing risk: issuer redeems early
Jameses: Special
Corporate Bond Features
convertible bond
has call option to convert to issuers’ common stock
exchangeable: … to other’s common stock
warrant: call options on predefined assets
debt with warrant: keep the debt when call assets
putable: option to sell back at par on date t
zero-coupon: can create from coupon bonds
(less real risk?)
floating-rate: coupon interest indexed
Corporate Bond Credit
Ratings
investment-grade
low credit risk, low yield
noninvestment-grade (‘junk bonds’)
high credit risk, high yield
big 80s growth to finance LBOs
original issues (70% in US 1992) v. downgraded
bonds
crowds out bank loans: public doesn’t risk
deferred coupon structures: lower early cash
pay
Secondary Corporate Bond
Markets
exchange market (NYSE, ASE…)
OTC market - larger: institutionals
brokers carry inventories, tying up dealer capital
% dealer capital tied up like this has declined [why?]
generally, dealers still in control: prices less
transparent, not publicly quoted
Eurobond Market
international syndicate underwrites bond
(i.e. buys all from issuer)
offered simultaneously to investors in
different countries
issued outside the jurisdiction of any
single country
issued unregistered (usually OTC)
main currency: $US, but less so
can be dual currency: coupon, principal differ
Preferred Stock
 like stock, get dividends, but paid at pre-specified
‘dividend rate’
 missing payments doesn’t bankrupt:
cumulative preferred stock: missed dividend payments accrue (if
noncumulative, just lose it)
imposition of restrictions on management: e.g. gain voting
rights
 US tax code: dividends not as tax-deductible interest
payments unless recipient is corporation
thus, most preferred stock holders are firms
buy s-r preferred to get tax breaks for excess cash
 usually sinking fund provision; some convertible for
common
Types of Preferred Stock
perpetual: no maturity
fixed-rate: historical
adjustable-rate: dividend reset on T-bills; most
perpetual, floor/ceiling on dividend rate; not
putable (holder ‘stuck’ with it)
auction: as ARPS but auction resets dividend
rate
remarketed: as ARPS but remarketing agent to
ensure sells at par
APS and RPS dominant in US since 1985