BORROWING

1
BORROWING

• Debt Administration
• Debt Structure Design
• Appropriate Debt Policy

2
THE NATURE OF BORROWING

• A transaction involving two parties, the borrower
  and the lender
• Borrowers get purchasing power now in return for
  an obligation to repay later
• Lenders give up current purchasing power in
  return for the promise of repayment later
• Bonds are the standard form taken by long-term
  obligations to repay debt

3
Vanilla BONDS

• Obligations to pay a face amount or par value
  (principal) at a specified retirement or maturity
  date and to make contractual interest payments
  until the debt is retired
• The stated or nominal interest on a bond is its
  coupon rate, the percentage of par value that
  will be paid on a regular basis, usually
  biannually. For example, a 9 coupon rate means
  that the bond pays 90 per 1000 each year
• Issuers sell bonds
• Bond holders buy them, either at issue or in
  secondary markets

4
Yield

• Yields often differ from coupon rates
  substantially
• The present value of the bond may differ from the
  face value substantially
• Markets set bond values and implicitly a bonds
  discount rate (reflecting the current time value
  of money)
• The current bond price equals the present value
  of the cash flow to which the bondholder is
  entitled

5
DEBT STRUCTURE AND DESIGN

• CRITERIA
• Least-cost marketability
• Ease of administration
• Provision of appropriate cost signals
• Appropriate risk characteristics

• VARIABLES
• Type of security (denomination, backing)
• Maturity
• Term or Serial
• Options and derivative issues

6
Bids

• DETERMINATION
• Denomination
• Yield Structure of Bond
• The economy and governance of the bond issuer
• Its debt history
• Rating
• Availability of Bond Insurance

• EVALUATION
• Underwriters package and sell government debt
• TIC -- use IRR function on spreadsheet to
  calculate

7
DEBT POLICY

• REASONS FOR DEBT
• Revenue shortfalls
• Structural deficits
• Cyclical deficits
• Temporary liquidity problems due to the timing of
  cash flows
• Capital-project construction

• CONSIDERATIONS
• Borrowing cost vs. tax cost
• Effect upon future solvency -- you really want to
  be able to borrow when you need to, not just when
  you want to
• Timing