MARKETS FOR CORPORATE SENIOR INSTRUMENTS: II

1
Chapter 21

• MARKETS FOR CORPORATE SENIOR INSTRUMENTS II

2
Corporate Senior Instruments

• Corporate Bonds
• Classified by type of issuer industrials gt
  banks/finance companies gt utilities
• Investors life insurance companies, pension
  funds (mostly institutional)
• Preferred Stock

3
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

4
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

5
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

6
Jameses Special Corporate Bond Features

• convertible bond
• has call option to convert to issuers common
  stock
• exchangeable to others 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

7
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 doesnt risk
• deferred coupon structures lower early cash pay

8
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

9
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

10
Preferred Stock

• like stock, get dividends, but paid at
  pre-specified dividend rate
• missing payments doesnt 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

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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