M4: Fixed-Income Markets for Corporate Issuers

What are the main short-term external funding alternatives for non-financial corporations?

Bank lines of credit, secured loans/asset-based lending, receivables financing, and commercial paper.

What are the three main types of bank credit lines, from least to most reliable?

Uncommitted line → committed line → revolving credit agreement (revolver).

What is an uncommitted line of credit?

A bank indicates a maximum amount a borrower may draw, but retains the right to refuse a draw request.

Why is an uncommitted line the least reliable bank funding source?

The bank is not formally committed to provide the funds and can refuse a draw.

Does an uncommitted line normally have an upfront commitment fee?

No.

How is borrowing under an uncommitted line typically priced?

MRR + an issuer-specific spread on amounts actually borrowed.

What is a committed line of credit?

A formal written bank commitment to lend up to a specified amount over a defined period.

How reliable is a committed line compared with an uncommitted line?

More reliable because the bank formally commits to lend, but it still faces renewal risk at maturity.

What maturity is typical for a regular committed line?

Usually 364 days or less.

Why are committed lines often structured for 364 days or less?

This minimizes the bank's regulatory capital requirement.

What fee is commonly associated with a committed line?

An upfront commitment fee, often charged on the full or unused portion of the facility.

What is a revolving credit agreement (revolver)?

A multiyear committed bank facility that allows repeated borrowing and repayment, usually subject to covenants.

Which bank credit facility is generally the most reliable?

A revolving credit agreement.

What is the key exam relationship between reliability and commitment fees?

Uncommitted = no commitment fee but least reliable; committed/revolver = fees but greater reliability.

What is a secured loan or asset-based loan?

A loan backed by pledged collateral such as receivables, inventory, marketable securities, or fixed assets.

Why might a company use a secured loan instead of an unsecured loan?

It may be unable to qualify for unsecured borrowing or may obtain financing by pledging assets.

What is an assignment of accounts receivable?

Receivables are pledged as collateral for a loan, but the company remains responsible for collecting them.

What is factoring?

The company sells its receivables to a factor at a discount, and the factor assumes collection and credit responsibilities.

What is the key difference between receivables assignment and factoring?

Assignment = receivables pledged and company still collects; factoring = receivables sold and factor collects.

What is commercial paper (CP)?

Short-term unsecured notes issued by large, highly rated companies.

What does corporate commercial paper typically finance?

Working capital, seasonal cash needs, and bridge financing.

What is bridge financing?

Temporary financing used until more permanent financing can be arranged.

How is maturing commercial paper usually repaid?

By issuing new commercial paper, known as rolling over the CP.

What is rollover risk?

The risk that an issuer cannot issue new debt to repay maturing debt.

Does a high credit rating eliminate commercial-paper rollover risk?

No. Even highly rated issuers can face rollover risk.

What specifically addresses commercial-paper rollover risk?

A committed backup line of credit, also called a liquidity enhancement.

What is the purpose of a CP backup line?

To provide funds to repay maturing CP if the issuer cannot successfully roll it over.

Is a CP backup line primarily a liquidity enhancement or a credit guarantee?

A liquidity enhancement; it addresses rollover risk.

What is Eurocommercial paper (ECP)?

Commercial paper issued in the international market.

How does ECP generally compare with US commercial paper?

ECP transactions tend to be smaller and less liquid.

What are primary sources of corporate liquidity?

Cash and cash equivalents, available credit facilities, and normal access to capital markets.

What are secondary sources of corporate liquidity?

Asset sales, debt restructuring, and bankruptcy reorganization.

What does reliance on secondary sources of liquidity generally indicate?

The company is experiencing or approaching financial distress.

What are the main short-term funding sources for banks?

Deposits, certificates of deposit, interbank borrowing, commercial paper, and repos.

What are demand deposits?

Deposits such as checking accounts with no stated maturity that can be withdrawn for transactions.

Why can checking and operational deposits be attractive funding for banks?

They are often stable and relatively low-cost sources of funding.

What is a certificate of deposit (CD)?

A bank deposit with a predetermined maturity and interest rate.

What is a non-negotiable CD?

A CD that pays the original depositor at maturity and generally imposes a penalty for early withdrawal.

What is a negotiable CD?

A CD that can be sold to another investor in the market before maturity.

What is the interbank market?

A market in which financial institutions lend to and borrow from one another on secured or unsecured terms.

What is the central bank funds market?

A market where banks with surplus central-bank reserves lend to banks with reserve deficits.

What is the central bank funds rate?

The rate at which surplus central-bank reserves are lent between banks.

What may a bank do if it cannot obtain funding in the interbank market?

Borrow directly from the central bank as a last resort, usually at a higher rate and against collateral.

What is asset-backed commercial paper (ABCP)?

Short-term paper issued by an SPE and backed by a pool of assets such as short-term loans or receivables.

How does ABCP financing generally work?

A bank transfers assets to an SPE; the SPE raises cash by issuing ABCP to investors, usually with backup liquidity from the bank.

What is a repurchase agreement (repo)?

A sale of a security combined with an agreement by the seller to repurchase the same or similar security later at an agreed price.

What is the economic substance of a repo?

A secured cash loan.

Who is the cash borrower in a repo?

The security seller.

Who is the cash lender in a repo?

The security buyer.

From the cash lender's perspective, what is a repo called?

A reverse repurchase agreement (reverse repo).

Who earns the repo rate?

The cash lender/security buyer.

Who pays the repo rate?

The cash borrower/security seller.

Who retains the economic benefits of the collateral, such as coupon interest, during the repo?

The security seller/cash borrower.

What is the repurchase price formula?

Repurchase Price = Purchase Price₀ × [1 + Repo Rate × (Days ÷ 360)].

What does the difference between repurchase price and initial purchase price represent?

The interest paid by the cash borrower to the cash lender.

What is an overnight repo?

A repo with a one-day term.

What is a term repo?

A repo with a maturity longer than one day.

What is a general collateral repo?

A repo referencing a general group of acceptable collateral rather than one specific security.

What is the general collateral repo rate?

The repo rate applying to transactions using standard eligible collateral.

What is initial margin in a repo?

The ratio of the collateral's security value to the amount of cash lent.

What is the initial margin formula?

Initial Margin = Security Price₀ ÷ Purchase Price₀.

How do you calculate the repo purchase price when initial margin is given?

Purchase Price₀ = Security Price₀ ÷ Initial Margin.

What does an initial margin above 100% mean?

The collateral value exceeds the cash loan, providing protection to the cash lender.

What is a repo haircut?

The percentage reduction in the cash loan relative to the market value of the collateral.

What is the haircut formula?

Haircut = (Security Price₀ − Purchase Price₀) ÷ Security Price₀.

Is a 102% initial margin equivalent to a 2% haircut?

No. A 102% initial margin corresponds to a haircut of approximately 1.96%.

Why are initial margin and haircuts used?

To protect the cash lender against declines in collateral value.

What is variation margin?

A collateral adjustment during the life of a repo that restores the agreed initial margin.

What is the variation margin formula?

Variation Margin = (Initial Margin × Purchase Priceₜ) − Security Priceₜ.

What does positive variation margin indicate?

Undercollateralization; the cash borrower must post additional collateral.

What does negative variation margin indicate?

Overcollateralization; the cash borrower may request release of excess collateral.

What is a master repurchase agreement?

A legal agreement governing repo terms such as margining, collateral substitution, and events of default.

What are the three major uses of repos?

Finance ownership of securities; earn short-term secured income; borrow securities for short selling.

How can a dealer use a repo to finance ownership of a bond?

The dealer buys the bond and repos it out, borrowing most of the purchase price against the bond as collateral.

How much of a repo-financed security does the investor effectively need to fund with its own cash?

Approximately the haircut, because the remainder can be financed through the repo.

How can an investor earn short-term income using a reverse repo?

Lend cash against collateral and earn the repo rate.

How can repos facilitate short selling?

An investor obtains a security through a repo/reverse-repo transaction, sells it, and later repurchases it to return under the agreement.

How do central banks use repos?

To manage liquidity and the money supply on a temporary basis.

What are the main factors affecting repo rates?

Money-market rates, collateral quality, repo term, collateral uniqueness, and collateral delivery.

How does lower-quality collateral generally affect the repo rate?

It generally increases the repo rate.

How does a longer repo term generally affect the repo rate?

It generally increases the repo rate because of greater risk over a longer period.

How does highly desirable collateral affect its repo rate?

The repo rate may fall because borrowers are willing to accept a lower return on cash to obtain the desired security.

What is special collateral?

A specific security in unusually high demand that trades at a repo rate below the general collateral rate.

Can a special collateral repo rate be negative?

Yes, if demand for the particular security is sufficiently strong.

What is the primary risk in a repo?

Counterparty/default risk.

Does collateral eliminate repo default risk?

No. It mitigates potential losses but does not eliminate default, liquidity, or collateral-price risk.

What is collateral risk in a repo?

The risk that collateral loses value or becomes difficult to sell, particularly when the counterparty defaults.

What type of collateral relationship is desirable from a risk perspective?

Collateral whose value has low correlation with the counterparty's credit quality.

Why is highly correlated collateral dangerous?

The counterparty may default at the same time the collateral loses value.

What is margining risk?

The risk that required variation margin is inadequate or transferred too late.

What is legal risk in a repo?

The risk that close-out, collateral, or netting provisions cannot be legally enforced.

What is netting and settlement risk?

Risk surrounding the ability to offset obligations and obtain/control collateral following default.

What is a bilateral repo?

A repo conducted directly between the two principal counterparties.

What is a triparty repo?

A repo in which a third-party agent administers collateral custody, valuation, settlement, and margining.

What does the triparty agent primarily reduce?

Operational risk.

Does a triparty agent eliminate or change the credit relationship between the borrower and lender?

No. The underlying credit exposure remains between the principals.

What is the fundamental long-term financing trade-off faced by both IG and HY issuers?

Choosing maturity, coupon, and instrument structure while balancing financing cost and refinancing risk.

What generally happens to required YTM as maturity increases under normal market conditions?

YTM generally increases because benchmark yields and credit spreads tend to rise with maturity.

What risk does an investor take by buying a bond with maturity longer than the investment horizon?

Price risk and reinvestment risk.

What risk does an issuer take by borrowing for a maturity shorter than its funding horizon?

Rollover/refinancing risk.