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Raising Resources Corporate Debt

Raising Resources Corporate Debt. Session on Finance Sidharth Sinha Indian Institute of Management, Ahmedabad.

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Raising Resources Corporate Debt

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  1. Raising ResourcesCorporate Debt Session on Finance Sidharth Sinha Indian Institute of Management, Ahmedabad The views expressed here are those of the presenter and do not necessarily reflect the views or policies of the Asian Development Bank (ADB), or its Board of Directors, or the governments they represent.

  2. Financial Markets Money Primary Markets OTC Markets Secondary Markets

  3. Investors Issuers Primary Bond Markets Government Money Money Government Firms Firms Households Bonds Bonds Primary Bond Markets

  4. Investors Investors Secondary Bond Markets Government Money Government Money Firms Firms Households Households Bonds Bonds Secondary Bond Markets

  5. Financial Intermediaries Company Obligations Funds Intermediaries Banks Insurance Companies Brokerage Firms

  6. Financial Intermediaries Intermediaries Obligations Funds Investors Depositors Policyholders Investors

  7. Debt Terms and Conditions • Face value (principal) • Maturity • Coupon rate/Interest rate • Repayment • Security • Seniority

  8. Maturity • Call provision • Issuer right to buy the bond back at a set price • Right exercised at low interest rates • Issuer can call the bond and borrow at cheaper rates • Put provision • Investor right to sell the bond back at a set price • Right exercised at high interest rates • Investor can redeem the bond and invest the proceeds at a higher rate

  9. Interest Rate • Fixed • Interest fixed for the life of the bond • Bond value fluctuates with market interest rates • Bond value converges to face value at maturity • Floating • Interest defined as a base interest rate, e.g., LIBOR +/- spread • Bond value = face value after interest reset • Fixed/floating interest rate can be changed using interest rate swaps. • Zero coupon or deep discount bonds • Frequency of interest payment • Moratorium on interest payment

  10. Foreign Currency Bonds • Interest rate and principal are fixed in foreign currency • Issuer subject to foreign currency risk due to change in the value of the foreign currency • Can be hedged using derivatives – forwards or swaps • If interest rate parity holds then the domestic currency cost of the foreign currency bond after hedging should be equal to the cost of a domestic currency bond.

  11. Default Risk • Debt has the unique feature of allowing the borrowers to walk away from their obligation to pay, in exchange for the assets of the company. • “Default risk” is the term used to describe the likelihood that a firm will walk away from its obligation, either voluntarily or involuntarily. • “Bond ratings” are issued on debt instruments to help investors assess the default risk of a firm.

  12. Corporate Debt: Some Terminology • Prime rate - Benchmark interest rate charged by banks. • Sinking fund - Fund established to retire debt before maturity. • Subordinate debt - Debt that may be repaid in bankruptcy only after senior debt is repaid. • Secured debt - Debt that has first claim on specified collateral in the event of default. • Investment grade - Bonds rated BAA or above by Moody’s or BBB or above by S&P. • Junk bond - Bond with a rating below BAA or BBB

  13. Corporate Debt: Some Terminology (continued) • Eurodollars - Dollars held on deposit in a bank outside the United States. • Eurobond - Bond that is marketed internationally. • Private placement - Sale of securities to a limited number of investors without a public offering. • Protective covenants - Restriction on a firm to protect bondholders. • Convertible bond - Bond with an option to convert into a specified number of shares after a specified time.

  14. IMF - Global Development Finance 2004 • Three issues to be addressed in tapping global & domestic capital markets to meet the infrastructure financing needs of developing countries: • First, a strong institutional framework for the protection of creditors’ rights, effective covenants, and reliable avenues of legal enforcement and remedy. • Second, growth, maturation, and stability in local capital markets-these markets provide both long-term local-currency financing and hedging against exchange-rate risk. • Third, a renewed effort to improve the creditworthiness of public infrastructure providers-both to facilitate their access to capital markets and to make private equity investment in public-private ventures less risky.

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