1 / 37

Chapter 19

Chapter 19. Business Borrowing: Corporate Bonds, Asset-Backed Securities, Bank Loans, and Other Forms of Business Debt.  Learning Objectives . To look at how business firms issue debt securities and negotiate loans in order to raise funds in the money and capital markets.

bart
Download Presentation

Chapter 19

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter 19 Business Borrowing: Corporate Bonds, Asset-Backed Securities, Bank Loans, and Other Forms of Business Debt

  2.  Learning Objectives  • To look at how business firms issue debt securities and negotiate loans in order to raise funds in the money and capital markets. • To learn about the key factors affecting the volume of funds that businesses seek to raise in the financial system. • To see the often powerful impact that business borrowing has upon market interest rates and credit conditions. 19-2

  3. Introduction • Business firms draw on a wide variety of fund sources to finance their daily operations and to carry out long-term investment. • In 2006, nonfinancial business firms in the U.S. raised nearly $1.9 trillion, of which approximately $516 billion was supplied from the financial markets through issues of bonds, stocks, notes, and other financial instruments. 19-3

  4. Factors Affecting Business Activity in the Money and Capital Markets • Many factors affect the extent to which business firms draw on the money and capital markets for external funds: • Total funding demands of business firms • Level and expected growth of internally generated funds • Condition of the economy • Credit availability and interest rates 19-4

  5. Characteristics of Corporate Notes and Bonds • Maturity definition • A note has an original maturity of five years or less • A bond carries an original maturity of more than five years • General characteristics • An amount equal to the par value at maturity • Interest payments at specified intervals • Generally issued in units of $1,000 • Accompanied by indentures 19-5

  6. Characteristics of Corporate Notes and Bonds • Corporate bonds tend to be issued with longer maturities when both interest rates and inflation are low • Some corporate bonds are backed by sinking funds • A considerable proportion of corporate bonds that are outstanding today carry call privileges 19-6

  7. Characteristics of Corporate Notes and Bonds • During rapid economic expansion • The supply of credit is relatively scarce • The cost of borrowing rises • Yield movements • Yields on the highest-grade bonds tend to move closely with government bond yields • Yields carried by lower-grade corporate bonds • More tied to conditions in the economy • Also tied more to factors specifically affecting the risk position of the borrower 19-7

  8. Characteristics of Corporate Notes and Bonds For a bond that matures in 10 years: • Interest charges on debt are tax deductible, so k’ = k (1 – t) 19-8

  9. Characteristics of Corporate Notes and Bonds Signals Corporate Bond Issues May Send • A bond issue that appears to be driven by an unanticipated cash-flow shortage • Tends to lower bond prices of the issuer • Tends to lower equity prices of the issuer • A new bond sold to expand the firm’s capitalization tends to send a positive signal to the market 19-9

  10. Characteristics of Corporate Notes and Bonds • Common types of corporate bonds • Debentures – Unsecured by a specific asset • Subordinated debentures – junior securities • Mortgage bonds – closed end or open end • Income bonds – interest is paid only when income is actually earned • Equipment trust certificates – resemble leases • Industrial development bonds (IDBs) – issued by a local government borrowing authority 19-10

  11. Characteristics of Corporate Notes and Bonds • Innovations in corporate debt include: • Discount bonds – including zero coupon bonds • Floating-rate bonds • Commodity-backed bonds – face value is tied to the market price of an internationally traded commodity • Inflation-linked corporate notes • Medium-term notes (MTNs) – carry maturities of one to ten years 19-11

  12. Asset-Backed Securities Issued by Corporations • Securitization • The process that gives rise to the creation of asset-backed securities (ABS) • Example: Packaging group of home mortgages • Usually with federal agency guarantees • Removed from the lenders’ balance sheets • Placing them in a separate trust account • Selling securities backed by mortgages • With the help of an investment bank 19-12

  13. Asset-Backed Securities Issued by Corporations 19-13 19 - 13

  14. Asset-Backed Securities Issued by Corporations • Securitization may: • Reduce the cost of raising funds • Grant companies greater control over their balance sheets • Help a company avoid the issuance of additional balance-sheet debt • Improve the apparent financial strength of an issuing firm • Permit greater asset diversification • Provide a new source of company earnings 19-14

  15. Asset-Backed Securities Issued by Corporations 19-15 19 - 15

  16. Investors in Corporate Debt • The market is institution dominated • Pension funds prefer public corporate debt • Insurance companies frequently prefer private placement • Foreign institutions are a very dynamic sector of the market • Many dealers are international • Many of the debt instruments are for foreign takeovers of U.S. companies • Many more are ways to access dollars 19-16

  17. Investors in Corporate Debt • Rapid growth in debt instruments in the U.S. • Not matched by rise of U.S. resident bond holdings • Differential filled by foreign investors • Bonds by U.S. companies between 1995 and 2006 • Tripled from $2.5 trillion to $8.2 trillion • Foreign investment went from $461 billion to $2.7 trillion 19-17

  18. Investors in Corporate Debt Principal Investors in Corporate and Foreign Bonds, 2006 Source: Board of Governors of the Federal Reserve System, Flow of Funds Accounts: Financial Assets and Liabilities, Fourth Quarter 2006. 19-18

  19. The Secondary Market for Corporate Debt • The secondary market for corporate debt • Relatively limited compared to the markets for other long-term securities • The number of active individual investors is small • Institutional investors tend to follow a buy and hold strategy • Some changes in strategies more recently • Many institutions are looking at total performance • Have become more aggressive 19-19

  20. The Marketing of Corporate Debt • Corporate bonds may be offered publicly • Through a public sale • Sold privately to a limited number of investors via a private or direct placement • The majority of offerings are public sales • Popular with firms having unique financing requirements • Private placements are common among smaller companies 19-20

  21. The Marketing of Corporate Debt • The decision of small firms is often a function of the nature of the market • Economies of scale in public issuance of debt • So relatively cheaper for firms with large debt issuances • For smaller firms with less debt the public market is relatively more expensive • The flexibility of private issues • More easily address potential agency costs • Allow smaller debt issues 19-21

  22. The Marketing of Corporate Debt • A public sale uses an underwriter • An investment banking firm or a syndicate of underwriters may do one of two things • Purchase the securities directly from the issuing company through a bidding process • Guarantee the issuer a specific price • The underwriter carries the risk of losses (or gains) when the securities are marked for sale in the open market 19-22

  23. The Marketing of Corporate Debt • Private placements have accounted for about 10% of market sales of corporate bonds • Interest rates influence the private versus public decision • Rising interest rates bring more borrowing companies into the public market • Falling interest rates often bring about a rise in private placements 19-23

  24. The Volume of Borrowing by Corporations 19-24

  25. The Volume of Borrowing by Corporations • Growth in corporate borrowing is due to: • Inflation • The increased use of financial leverage to boost returns to corporate stockholders • The development of international capital markets • Recent relatively-low interest rates • The rash of corporate takeovers (leveraged buyouts) and mergers 19-25

  26. The Volume of Borrowing by Corporations • Also more borrowing due to corporate stock retirements • A significant growth in popularity • Among larger corporations • Stock retirements exceeded $400 billion for the year ending in June 2006 • Was only $130 billion in 2001 • Various factors for the expansion • More M&A activity • More companies tapping the debt market 19-26

  27. Bank Loans to Business Firms • Commercial banks are direct competitors with the corporate debt markets • Making both short-term and long-term loans to businesses • Growing numbers of corporations have turned to selling securities in the open market • The volume of bank credit for business firms remains enormous 19-27

  28. Bank Loans to Business Firms • The Fed has been carrying out surveys • Examine business lending practices • Look at banks across the U.S. • Surveys indicate bank lending tends to be short-term • Average maturity of commercial and industrial loans (value-weighted) was 524 days in February 2007 • Longer term loans averaged 54 months 19-28

  29. Bank Loans to Business Firms • The prime bank rate, or base rate • The annual percentage rate that banks quote to their most creditworthy customers • Tend to be unsecured • Often require compensating balances • These tend to be short-term loans • Traditionally, the prime rate was set by one or more of the nation’s leading banks • Now, prime rates are often pegged to the prevailing yields on Treasury bills 19-29

  30. Commercial Mortgages • Commercial mortgage • The construction of commercial structure • Office buildings • Shopping centers • Other commercial structures • Faced with inflation and a volatile economy, new forms have been developed: • equity kicker • indexing • asset-backed securitization 19-30

  31. Markets on the Net • American Capital Advance at americancapitaladvance.com • Amerimerchant at amerimerchant.com • Asset Securitization Report at asreport.com • Bankrate.com at bankrate.com • Bond Market Association at www.investinginbonds.com/ • Bond Market Association – European Issues at www.bondmarkets.com/ 19-31

  32. Markets on the Net • British Bankers’ Association at www.bba.org.uk • Business.com at www.business.com • CBS Marketwatch at www.cbs.marketwatch.com/ • CNN/Financial at www.cnnfn.com • Financial Pipeline at www.finpipe.com • Mortgage 101 at www.mortgage101.com 19-32

  33. Markets on the Net • National Association of Small Business Investment Companies at nasbic.org • REBUZ – Commercial Mortgages at www.rebuz.com • Small Business Notes at smallbusinessnotes.com • St. Louis Federal Reserve Bank research at research.stlouisfed.org/fred2 • Wikipedia at en.wikipedia.org 19-33

  34. Chapter Review • Introduction to business borrowing • Factors affecting business activity in the money and capital markets 19-34

  35. Chapter Review • Characteristics of corporate notes and bonds • Principal features • Recent trends in original maturities • Call privileges • Sinking fund provisions • Yields and costs • Signals corporate bond Issues may send • The most common types of corporate bonds • Innovations in corporate debt 19-35

  36. Chapter Review • Asset-backed securities Issued by corporations • Investors in corporate debt • The secondary market for corporate debt • The marketing of corporate debt • Public sales • Private placements • The volume of borrowing by corporations 19-36

  37. Chapter Review • Bank loans to business firms • The volume of bank credit supplied to businesses • The prime, or base, Interest rate on business loans • Other examples of base rates for business loans • Commercial mortgages 19-37

More Related