Chapter 21

1. Chapter 21 MARKETS FOR CORPORATE SENIOR INSTRUMENTS: II

2. 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

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. 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

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 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

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 doesn’t 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 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

11. 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