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Fixed Inc. Chapter 7: CORPORATE DEBT INSTRUMENTS
Terms in this set (102)
___________ _______ ____________ are financial obligations of a corporation that have priority over its common stock and preferred stock in the case of bankruptcy.
Corporate debt instruments
Issuers of corporate debt obligations are categorized into the following three sectors: _____, _______, and ________.
Utilities, financial and industrials
Includes investor-owned companies that are involved in the generation, transmission, and distribution of electric, gas, and water.
Includes bonds of the wide range of financial institutions such as banks, insurance companies, securities firms, brokerage firms, mortgage firms, and finance companies.
Includes companies that are not utilities or financials.
The Capital Structure of a firm consists of what?
Common stock, preferred stock and debt.
The different creditor classes are classified as follows:
Senior secured debt, Senior unsecured debt, Senior subordinated debt, and Subordinated debt.
Senior Secured Debt
Backed by or secured by some form of collateral beyond the issuer's general credit standing. Either real property (suing a mortgage) or personal property may be pledged to offer security.
Grants the creditor a lien against the pledged assets. The creditor has a legal right to sell the mortgaged property to satisfy unpaid obligations that are owed. Foreclosure and sale of mortgaged property is unusual. Often times they pledge other things that they own.
Collateral Trust Bonds
Bonds backed by financial assets.
Senior Unsecured Debt
Debt that isn't secured by a specific pledge or property. This doesn't mean that the creditors holding this type of debt have no claim on property of issuers or on their earnings.
Bonds that are issued with priority against claims.
A class of unsecured debt that ranks below a firm's senior unsecured obligations.
Senior Subordinated Debt
The class of debt that has seniority within the ranks of subordinated debt.
One purpose of the bankruptcy law is to set forth the rules for a corporation to be either liquidated or __________.
Liquidation of a Corporation
All the assets will be distributed to the holder of claims of the corporation and no entity will survive.
A new corporate entity is created from bankruptcy.
Debtor in Possession (DIP)
A company that files for protection under the bankruptcy act becomes this, and continues to operate its business under the supervision of the Court.
The bankruptcy act is composed of how many chapters?
Chapter 7 Bankruptcy
Deals with liquidation of a company. Less common!
Chapter 11 Bankruptcy
Deal with the reorganization of a company.
Absolute Priority Rule
The principle that senior creditors are paid in full before junior creditors are paid anything.
The evaluation of credit risk; the evaluation of the creditworthiness of a borrower or counterparty.
Entities that assign credit ratings and have been approved to do so by the Securities and Exchange Commission (SEC) are more formally referred to as:
Nationally Recognized statistical rating organizations (NRSROs)
The three major NRSROs are:
Moody's Investors Service, Standard & Poor, Fitch Inc.
Means low credit risk.
Debt obligations that are assigned a rating in the top four categories.
Issues that carry a rating below the top four categories.
High-Yield Debt/Junk Debt
Also refer to Noninvestment-Grade.
Bonds issued by corporations that typically pay higher interest than government bonds.
Bonds that run for a term or years, and then become due and payable.
Obligations under 10 years from the date of issue are called:
Corporate borrowing due in 20 to 30 years are referred to as:
Some corporate bond issues are arranged so that specified principal amounts become due on specified dates.
A provision in a bond contract that gives the issuer the right to redeem the bonds under specified terms prior to the normal maturity date.
Call Price (Regular Price, General Redemption Price)
Price that the issuer must pay to retire the issue and may be a single price or a call schedule.
Sets forth a call price based on when the issuer exercises the option to call the bond.
Special Redemption Price
Price for debt redeemed through the sinking fund and through other provisions.
A bond provision stating that the bond can't be called until a set number of years have passed since it was issued.
First Call Date
The date at which the issue may first be called.
Currently Callable Issue
If a callable bond doesn't have any protection against early call.
Refunding a Bond Issue
Redeeming bonds with funds obtained through the sale of a new bond issue, often at a lower interest cost.
Bonds that are noncallable for the issue's life are more common than bonds that are nonrefundable for life but otherwise callable?
A noncallable bond still provides _______ assurance against premature and unwanted redemption than does refunding protection.
Pay entire principal in one lump sum at maturity. Bonds that can be called in whole or in part.
With a _________ call provision, the call price is fixed and is either par or a premium over par based on the call date.
Make-Whole Call Provision
The payment when the issuer calls a bond is determined by the present value of the remaining payments discounted at a small spread over a maturity-matched Treasury yield.
The specified spread which is fixed over the bond's life.
Sinking Fund Requirement
A restrictive provision often included in a bond indenture, providing for the systematic retirement of bonds prior to their maturity.
This kind of provision for repayment of corporate debt may be designed to liquidate all of a bond issue by the maturity date, or it may be arranged to pay only a part of the total by the end of the term. If only a part is paid, the remainder is called this.
Accelerated Sinking Fund Provision
Some bond issues include a provision that grants the issuer the option to retire more than the amount stipulated for sinking fund retirment.
Legal agreement between the bond issuers and bond investors.
Restrictions placed on the borrower.
Original-Issue High-Yield Bonds
Bond issues that have been rated noninvestment grade at time of issuance.
Bonds that drop into junk territory.
Deferred Coupon Structures
Permit the issuer to avoid using cash to make interest payments for a period of three to seven years. Often used to reduce the financial burden involved in leverage buyouts (LBOs).
Three types of deferred coupon structures:
Deferred-interest bonds, Step-up bonds, and, Payment-in-kind bonds.
Most common type of deferred coupon structure. These bonds sell at a deep discount and don't pay interest for an initial period, typically 3 to 7 years.
Do pay coupon interest, but the coupon rate is low for an initial period and then increases ("steps up") to a higher coupon rate
Payment-in-Kind (PIK) Bonds
Give the issuer an option to pay cash at a coupon payment date or give the bondholder a similar bond.
Requires the issuer to reset the coupon rate so that the bond will trade at a predetermine price. The new rate will reflect the level of interest rates at the reset date, and the credit spread the market wants on the issue at the reset date.
Interest that has built up but has not yet been paid.
Five Types of electronic corporate bond trading systems:
Auction systems, Cross-matching systems, inter-dealer systems, Multi-dealer systems, and Single-dealer systems.
Allow market participants to conduct electronic auctions of securities offerings for both new issues in the primary markets and secondary market offerings.
Bring dealers and institutional investors together in electronic trading networks that provide real-time or periodic cross-matching sessions. Buy and sell orders are executed automatically when matched.
Allow dealers to execute transactions electronically with other dealers via the anonymous services of "brokers' brokers".
Multi-Dealer Systems/Client-to-Dealer Systems
Allow customer with consolidated orders from two or more dealers that give the customers the ability to execute from among multiple quotes.
Permits investors to execute transactions directly with the specific dealer desired; this dealer acts as a principal in the transaction with access to the dealer by the investor, which increasingly has been through the Internet.
SEC Rule 144A
Allows the trading of privately placed securities among qualified institutional buyers.
Medium-Term Notes (MTN)
A corporate debt instrument, with the unique characteristic that notes are offered continuously to investors by an agent of the issuer. They are distributed to investors when they are initially sold.
All-In-Cost of Funds
Cost of the funds raised after consideration of registration and distribution costs.
Bonds that are based on stocks, bonds, commodities, or currencies.
The process of customers inquiring of issuers or their agents to design a security.
Equity-Linked Notes (ELN)
Economically equivalent to a portfolio consisting of a zero-coupon bond and a call option on the equity index.
Tied to the price performance of a designated commodity (oil) or a basket of commodities. At the maturity date, the investor receives the initial principal amount plus a return based the percentage change in the price of the designated commodity or basket of commodities.
Credit-Linked Note (CLN)
Pays a return linked to a global foreign-exchange index. Typically, this structured note is short-term, paying out a fixed minimum rate of interest determined by the movement in foreign exchange rates over the life of the note. On the maturity date, the note pays the initial principal amount plus return, if any.
A fixed-income security structured product, comprised of a bond and an option component that promise a minimum return equal to the investor's initial investment if held to maturity.
Short-term unsecured debt issued by large corporations. Minimum transaction is $100,000. Maturity ranges from one day to 270 days.
The risk that a company will not be able to sell new commercial paper to replace maturing paper.
Directly Placed Paper
Commercial paper that is sold to large investors without going through an agent or broker-dealer.
Dealer-Placed Commercial Paper
Requires the services of an agent to sell an issuer's paper.
Eligible paper that is rated "1" by at least two of the rating agencies.
Eligible paper that is not a tier-1 security.
Bank loans to corporate borrowers are divided into two categories:
investment-grade loans and leveraged loans.
A bank loan ade to corporate borrowers that have an investment-grade rating.
A bank loan to a corporation that has a below-investment-grade rating.
Syndicated Bank Loan
Single loan funded by group of banks. Used by borrowers who seek to raise large amounts of fund in the loan market rater than through the issuance of securities. Assignment or Participation
Senior Bank Loans
Underwritten by the investment bank, syndicated to institutional buyers.
Structures in which no repayment of the principal is made until the maturity date.
Method of Assignment
Holder of a loan who is interested in selling a portion can do so by passing the interest in the loan. The seller transfers all rights completely to the holder of the assignment, called the assignee.
Privity of Contract
The relationship that exists between the promisor and the promisee of a contract.
Involves a holder of a loan "participating out" a portion of the holding in that particular loan.
Collateralized Loan Obligation (CLO)
Securities issued against a portfolio of loans with different degrees of credit quality.
The entity responsible for managing the portfolio of leverage loans.
Has lowest priority and serves as the
Senior Bond Class
Class A in the capital structure, the one with AAA rating.
Cash Flow Waterfalls
Specify the order in which bond classes get paid and by doing so enforce the seniority of one CLO creditor over another.
Important because the outcomes of these tests can result in a diversion of cash that would have gone to the subordinated bond classes and redirect it to senior bond classes.
Period of time in which collateral principal is not distributed to the bond classes or the equity tranche but instead reinvested by the collateral manager by purchasing additional loans.
Default Loss Rate =
Default Rate x (100% - Recovery Rate)
Defaults occur for a variety reasons:
Missing payments, bankruptcies, and distressed exchanges.
Three factors are responsible for wide fluctuation in default rates:
(1) Default rates change because over time there are changes in the credit quality of high-yield bonds.
(2) Aggregate default rates vary with the state of the economy. In recessionary periods default rates rise and during expansionary periods default rates decline. (3) It has been observed that defaults are most likely to occur three years following the issuance of a high-yield bond. Consequently, the length of time that high-yield bonds have been outstanding will influence the default rate, what is referred to as the "aging effect."
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