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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.

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chapter 21

Chapter 21

MARKETS FOR CORPORATE SENIOR INSTRUMENTS: II

corporate senior instruments
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
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: II
basic features of corporate bonds iii
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
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
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
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
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
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
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
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