The Debt Market

The Debt Market

1. Overview

   • Credit is Debt (Loans & bonds)
   • Users
     • Comps
       • Interest paid to service the loan is tax-deductible -> cheaper than equity
     • Govts
       • their only other sources of income is from taxing their citizens
         • not enough in recessions
         • risk making them unpopular
   • Difference btw loans & bonds
     • A bond is a tradable loan
       • Banks make loans but the much bigger institutional investors buy and sell bonds
     • Bond market much bigger than loan market
       • Loans --[securitisation]--> bonds
   • Bonds
     • Issuer pays interest on the bond and repay the principal on the bond's maturity
       • Old days: bonds = physical cards, interest portion printed as a series of coupons -> interest = Coupon
     • Most are fixed interest bonds
       • Fixed income instruments
     • Those w/ floating interest rates are called FRNs (floating rate notes)
     • Eurobonds
       • Bonds traded internationally
         • First international bonds in 1960s issued in Europe

2. How bonds are issued

   • Most bonds are avail. in denominations of around $10000
     • Denomination = face value
     • Bonds issues tend to be for several hundred mil -> several bil. otherwise uneconomic & unpopular
   • Origination / Primary market activity
     • A borrower issues a bond w/ advice & assistance of an IB to arrange, distribute & underwrite the issue
       • Institutional investors buy the bonds issued -> bondholders
   • Secondary market
     • Bondholders sell bonds subsequently
       • Issuers may not know exactly who the bondholders are at any particular moments
   • When banks underwrite issue
     • Create a syndicate of other banks to help bear the risk
       • First bank: lead manager
       • Others: managers
     • Bought deal: bank buy the whole issue, issuers get money immediately
       • Higher fee because the risk for the bank is higher

3. Sovereign Issues

   • Are bonds issued by Govts
     • Default sometimes
       • Eg: Argentina 1980s, Russia 1990s
       • No one will lend them until their debt is rescheduled
         • Periods of closed credit markets
     • US Govt: biggest borrowers, borrow at cheapest prices
       • If defaults -> end of Capitalism
       • Bonds called Treasuries
         • Issued by the US govt Treasury Department
     • UK: Bonds = Gilts

4. Basic Points

   • 1/100 of 1%
   • Used to compare an issuer's bond cost of borrowing vs that of govt
     • E.g. : an issuer whose coupon is 75 basis points above treasuries is doing well since it cost of borrowing is just 3/4 of a per cent above Gov bond

5. Rating Agencies

   • Issuers need a credit rating to issue a bond
     • B/c institutional investors & IB traders don't have time to analyse an issuer to see whether it will default on the bond or the coupon
   • Provide a rating & charge the issuer

6. Zero Coupon Bonds

   • No coupon
   • Issued at a discount to their face value
   • On maturity holders receive face value
   • aka Deep discount bonds
   • When investors don't have to pay income tax on the interest element