Chapter 24 Debt Financing
description
Transcript of Chapter 24 Debt Financing
Chapter 24
Debt Financing
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-2
24.1 Corporate Debt
• Leveraged Buyout (LBO)
– When a group of private investors purchase all the equity of a public corporation and finances the purchase primarily with debt
• For example, Hertz was taken private through an LBO.
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-3
Table 24.1 New Debt Issued as Part of the Hertz LBO
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-4
Public Debt
• The Prospectus
– A public bond issue is similar to a stock issue.
– Indenture• Included in a prospectus, it is a formal contract
between a bond issuer and a trust company.– The trust company represents the bondholders and
makes sure that the terms of the indenture are enforced.
– In the case of default, the trust company represents the interests of the bond holders.
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-5
Public Debt (cont'd)
• Corporate bonds almost always pay coupons semiannually, although a few corporations have issued zero-coupon bonds.
• Most corporate bonds have maturities of 30 years or less.
• The face value or principal amount of a bond is denominated in standard increments, most often $1000.
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-6
Public Debt (cont'd)
• Bearer Bonds– Similar to currency in that whoever physically
holds the bond certificate owns the bond
– To receive a coupon payment, clipping a coupon off the bond certificate
• Registered Bonds– The issuer of this type of bond maintains a list of
all holders of its bonds.
– Coupon and principal payments are made only to people on this list.
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-7
Types of Corporate Debt
• Unsecured Debt– in the event of bankruptcy, gives bondholders a
claim to only the assets of the firm that are not already pledged as collateral on other debt
– Notes• A type of unsecured corporate debt
• Notes typically are coupon bonds with maturities shorter than 10 years.
– Debentures• A type of unsecured corporate debt
• Debentures typically have longer maturities than notes.
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-8
Types of Corporate Debt
• Secured Debt– A type of corporate debt in which specific assets
are pledged as collateral.
– Mortgage Bonds• Real property is pledged as collateral that bondholders
have a direct claim to in the event of bankruptcy.
– Asset-Backed Bonds• Specific assets are pledged as collateral that
bondholders have a direct claim to in the event of bankruptcy.
• Can be secured by any kind of asset
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-9
Public Debt
• Seniority
– Seniority• A bondholder’s priority in claiming assets not already
securing other debt
• Most debenture issues contain clauses restricting the company from issuing new debt with equal or higher priority than existing debt.
– Subordinated Debentures• Debt that, in the event of a default, has a lower priority
claim to the firm’s assets than other outstanding debt
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-10
Public Debt
• Bond Markets
– International Bonds
• Domestic Bonds– Bonds issued by a local entity and traded in a local
market, but purchased by foreigners
– They are denominated in the local currency.
• Foreign Bonds– Bonds issued by a foreign company in a local market and
intended for local investors
– They are denominated in the local currency.
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-11
Public Debt (cont'd)
• Bond Markets
– International Bonds
• Foreign Bonds
– Yankee Bonds
» Foreign bonds in the United States
– Samurai Bonds
» Foreign bonds in Japan
– Bulldogs
» Foreign bonds in the United Kingdom
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-12
Public Debt (cont'd)
• Bond Markets
– International Bonds• Eurobonds
– International bonds that are not denominated in the local currency of the country in which they are issued
• Global Bonds– Bonds that are offered for sale in several different
markets simultaneously
– Global bonds can be offered for sale in the same currency as the country of issuance (unlike Eurobonds).
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-13
Private Debt
• Private Debt
– Debt that is not publicly traded• Has the advantage that it avoids the cost of
registration but has the disadvantage of being illiquid
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-14
Private Debt (cont'd)
• Term Loans
– Term Loan• A bank loan that lasts for a specific term
– Syndicated Bank Loan• A single loan that is funded by a group of banks rather
than just a single bank
– Revolving Line of Credit• A credit commitment for a specific time period,
typically two to three years, which a company can use as needed
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-15
Private Debt (cont'd)
• Private Placements
– Private Placement
• A bond issue that is sold to a small group of investors rather than the general public
– Because a private placement does not need to be registered, it is less costly to issue than public debt.
» In 1990, the SEC issued Rule 144A, which allows private debt issued under this rule to be traded by large financial institutions among themselves.
» Because this debt is tradeable between financial institutions, it is only slightly less liquid than public debt.
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-16
24.2 Other Types of Debt
• Sovereign Debt
– Sovereign Debt• Debt issued by national governments
– U.S. Treasury securities represents the single largest sector of the U.S. bond market.
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-17
Sovereign Debt
• The U.S. Treasury issues:
– Treasury Bills• Pure discount bonds with maturities up to 26 weeks
– Treasury Notes• Semi-annual coupon bonds with maturities of 2 to 10
years
– Treasury Bonds• Semi-annual coupon bonds with maturities longer than
10 years
• Long Bonds– Bonds issued by the U.S. Treasury with the longest
outstanding maturities (currently 30 years)
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-18
Sovereign Debt (cont'd)
• TIPS (Treasury-Inflation-Protected Securities)
– An inflation-indexed bond issued by the U.S. Treasury with maturities of 5, 10, and 20 years
– They are standard fixed-rate coupon bonds with one difference: The outstanding principal is adjusted for inflation.
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-19
Sovereign Debt (cont'd)
• Treasury securities are sold by auction.
– Two types of bids are allowed.• Competitive
– Competitive bidders submit sealed bids in terms of yields and the amount of bonds they are willing to purchase. The Treasury then accepts the lowest-yield (highest-price) competitive bids up to the amount required to fund the deal.
• Non-Competitive– Noncompetitive bidders (usually individuals) just submit
the amount of bonds they wish to purchase and are guaranteed to have their orders filled at the auction.
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-20
Sovereign Debt (cont'd)
• STRIPS (Separate Trading of Registered Interest and Principal Securities)
– Zero-coupon Treasury securities with maturities longer than one year that trade in the bond market
• The Treasury itself does not issue STRIPS. Instead, investment banks purchase Treasury notes and bonds and then resell each coupon and principal payment separately as a zero-coupon bond.
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-21
Municipal Bonds
• Municipal Bonds (Munis)
– Bonds issued by state and local governments
– They are not taxable at the federal level (and sometimes at the state and local level as well).
• Sometimes referred to as tax-exempt bonds
– Most pay semi-annual interest• Fixed Rate
• Floating Rate
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-22
Municipal Bonds (cont'd)
• Serial Bonds– A single issue of municipal bonds that are
scheduled to mature serially over a period of years
• General Obligation Bonds– Bonds backed by the full faith and credit of the
local government
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-23
Municipal Bonds (cont'd)
• Revenue Bonds– Municipal bonds for which the local or state
government can pledge as repayment revenues generated by specific projects
• Double-Barreled– Describes municipal bonds for which the issuing
local or state government has strengthened its promise to pay by committing itself to using general revenue to pay off the bonds
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-24
Asset-Backed Securities
• Securities made up of other financial securities
– Security’s cash flows come from the cash flows of the underlying financial securities that “back” it.
• Asset securitization
– The process of creating an asset-backed security
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-25
Asset-Backed Securities (cont'd)
• Mortgage-backed security
– Largest sector of the asset-backed security market
– Backed by home mortgages
– Largest issuers are U.S. government agencies and sponsored enterprises, such as the Government National Mortgage Association (GNMA).
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-26
Asset-Backed Securities (cont'd)
• GNMA-issued mortgage-backed securities are explicitly guaranteed against default risk by the U.S. government.
• Investors still have pre-payment risk– The risk that the bond will be partially (or wholly)
repaid earlier than expected.
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-27
Asset-Backed Securities (cont'd)
• Other government sponsored enterprises issuing mortgage backed securities:– Federal National Mortgage Association (FNMA)– Federal Home Loan Mortgage Corporation
(FHLMC or “Freddie Mac”)
• Student Loan Marketing Association (“Sallie Mae”)– Asset-backed securities backed by student loans
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-28
Asset-Backed Securities (cont'd)
• The entities on the previous slide are not explicitly backed by the full faith and credit of the U.S. government, but many believe there is an implicit guarantee.
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-29
Asset-Backed Securities (cont'd)
• Private organizations, such as banks, also issue asset-backed securities.– Backed by home mortgages, auto loans, credit
card receivables, and other consumer loans.
• Collateralized debt obligation (CDO)– A re-securitization of other asset-backed
securities.– Often divided into tranches that are assigned
different repayment priority.
Copyright ©2014 Pearson Education, Inc. All rights reserved. 24-30
24.3 Bond Covenants
• Covenants
– Restrictive clauses in a bond contract that limit the issuers from undercutting their ability to repay the bonds
• For example, covenants may
– Restrict the ability of management to pay dividends
– Restrict the level of further indebtedness
– Specify that the issuer must maintain a minimum amount of working capital