Ch 7.1: Debt Instruments

Question 1

Characteristics of corporate debt

Answer 1

Bonds or loans;

Shot-term vs long-term debt;

Private or public markets;

Secured, unsecured or subordinated debt;

Asset-specific or general funding;

etc.

Question 2

Loans: commited vs uncommited credit facilities

Answer 2

With an uncommitted credit facilty a bank agrees to lend to a counterparty, but can renege on that commimtment at any point. [similar to a put option]

With a committed credit facility a bank engages its capital during the entire period of the agreement.

Question 3

Bilateral vs syndicated loans

Answer 3

Bilateral - single bank, single corporate

Syndicated - multiple banks, single corporate

Question 4

Arranger [syndicated loans]

Answer 4

The arranger coordinates all negotiations, payments and administration between the parties during the life of the loan.

Question 5

Key types of syndicated loans/credits

Answer 5

Term loans

Revolving credit facilites

Question 6

Term loan typical characteristics

Answer 6

Committed credit facility

Up to 10 years, commercial paper (maturity less than a year)

Bullet maturity/amortizing loan

Floating rate

Used for fixed assets, e.g property, plant, equipment

Question 7

Revolving credit facility characteristics

Answer 7

Commited or uncommirred credit facility

Similar to a term loan but offers more flexibility in terms of drawdown, repayment and re-drawdown (drawdown is taking new loan or rolling an old one)

Used for working capital, e.g. inventories, receivables

Standby credit facilities are an uncommitted version of revolving credit

Question 8

What is an indenture?

Answer 8

An indenture is the contract governing a bond issue.

The provisions of an indenture are verified by a trustee during the life of the bond as a representative of the interests of the bondholders.

Question 9

LBO stands for a …

Answer 9

… leveraged buyout

Question 10

What is jumbo?

Answer 10

A very large bond issue.

Question 10

What is jumbo?

Answer 10

A very large bond issue.

Question 11

What are book runners?

Answer 11

Book runners are the lead underwriters selected to place the new issuance of bonds with investors.

Question 12

What is the role of the trustee?

Answer 12

The trustee verifies the indenture during the life of the bond as a representative of the interests of the bondholders.

Question 13

What the requirements for financial statements for corporates with public debt?

Answer 13

The corporate has to present audited financial statements on an annual basis and unaudited ones on a quarterly basis.

Other requirements may include a descripiton of the risks associated with the issuer and the business environment, information on the highest salaries wiithin the firm, etc.

Question 14

What is a note?

Answer 14

A note is the generic term for plain vanilla bonds.

Question 15

What is a debenture?

Answer 15

A debenture is usually unsecured long-term debt.

Question 17

What is a lien?

Answer 17

The right to keep posession of a property belonging to another person until a debt owed by that person is repaid.

Question 18

What is an equipment trust certificate (ETC)?

Answer 18

An ETC is used to finance for example cars, locomotives or airplanes and are collateralized by the equipment in question.

Question 19

What is a bullet bond?

Answer 19

A bullet bond is a zero coupon bond.

Accrued interest and principle are paid at maturity.

Question 20

What are medium-term notes program (MTNs program)?

Answer 20

MTN’s are a form of flexible financing available to borrowers with high to very high credit quality, as a longer term extension of the commercial paper market.

Dealers have no underwriting obligations and distribute MTNs on a best effort basis.

Once a borrower has registered an MTN program wtth the SEC, a borrower can enter the MTN market with offerings of different sizes and different coupon for different maturities.

Typically drawdowns from MTN programs are much smaller than standard bond issues, ranging between $20m and $50m.

Question 21

What are private placements?

Answer 21

Private placements are halfway between loans and bonds.

Their term is typically of longer duration (up to 30y) and they are placed primarily with insurance companies.

Flexible documentation and disclosure requirements.

Private placements are not always rated by credit rating agencies.

Question 22

2 types of private placements

Answer 22

True private placements are bilateral arrangements between a borrower and a creditor (an insurance company). They are collateralized and documentation and disclosure requirements are flexible.

A 144A security is a private placement with standardized documentation that can be traded by professional investors but that retail investors are barred from trading. Most are rated by credit rating agencies. 144A can be registered with the SEC. Registered 144A securities should be treated like bonds or debentures.

Question 23

What are convertables?

Answer 23

Convertables are a debt instrument that can be exchanged for a specified number of common shares at a predetermined conversion ratio when the holder decides to do so. Maturity does not exceed 10y.

The debt is normally issued by:

• R&D firms such as high-tech or biotech firms with much upside potential in case of success.
• Firms in the midst of restructuring with much upside potential in case of success.
• Healthy firms that believe their stock is undervalued, thereby delaying equity financing.

Question 24

What is a hybrid?

Answer 24

Hybrids combine bond and equity characteristics.

The most widely used hybrids are convertible bonds and prefferred stocks.

Question 25

What is a convertible preference/preferred stock?

Answer 25

A convertible preference share pays dividends at a fixed/floating rate before common stock dividends are paid and can be exchanged into common shares.

Question 26

What is a commercial paper program (CP program)?

Answer 26

Maturity less than 1y.

Available only to the most creditworthy corporates.

Unsecured debt.

Proceeds normally used to finance working capital.

Question 27

Bonds vs loans charachteristics

Answer 27

Loans have a more flexible underwriting process.

Bonds have longer terms than loans.

Bonds tend to pay fixed rates while loans tend to pay floating rates.

Bonds are tradable in the secondary market whyle loans are more illiquid.

Question 28

Types of leases?

Answer 28

Capital leases are used to finance equipment purchases and are generally on-balance-sheet financings, as they are fully amortized and are not cancelable.

Operating leases are more akin to rent. They are generally not fully amortized and contain a cancellation clause allowing the lesse to return the quipment before the expiration of the contract. Therefore operational leases are often off-balance-sheet liabilities.

Question 29

What is factoring?

Answer 29

A form of receivables financing.

Factoring is done through the assignment of receivables to a factoring company, which pays the assignor immediately, discounting the amount to reflect the collection time and risk.

Question 30

What is a securitization?

Answer 30

Securitization is the financial practice of pooling various types of contractual debt and selling their related cash flows to investors as securities (bonds, pass-through certificates or CDOs/CLOs/agencies/RMBS/CMBS/ABS).

Securitization is similar to factoring, but securitizations do not make use of a third party. Receivables are rather sold directly to the end investors.

Securitization is a financing technique that is widely used by financial intermediaries (banks) to monetize financial assets.

Question 31

Types of corporate debt

Answer 31

Loans - bilateral, syndicated

Commercial Paper Programs (1y)

Medium-Term Notes Programs

Notes, Bonds, Debentures

Private Placements - true private placements, 144A securities

Hybrids - convertibles, preference stock

Lease financing, Factoring, Securitizations