AFM 274 - Chapter 24

Why is the debt market bigger than the equity market? (5)

• issuing more equity can send wrong message (info asymmetry)

• debt is easier to issues

• guaranteed payouts for debt compared to equity (more attractive)

  • most people are very risk-adverse

• debt avoids dilution of ownership

• debt comes with the interest tax shield benefit

Types of corporate public bonds (4)

• notes (short-term, not secure)

• debentures (long-term, not secure)

• mortgage bonds (secure, real asset bound)

• asset-backed bonds (secure, income-generating assets bound, not always real assets, like A/R)

Types of private debts (3)

• term loans (bank loans)

• revolving line of credit (bank loan, set of debt/tank of cash reserves)

• private placement (bonds sold to a small group of investors)

  • cheaper as less people involved, but riskier as less regulations (less reasons for firm to behave)

  • (slightly) higher interest rates for risk

  • not public, so liquid

what are some international bonds?

• domestic bonds

  • A issuing bonds in A but B can also buy it ig

    • currency is A-D

• foreign bonds

  • A issuing bonds in B in D-B currency (opposite of eurobonds)

• eurobonds:

  • A issuing bonds in B in non D-B currency (opposite of foreign bonds)

  • currency of the bond is different from the currency of the country receiving the bond (not issuing country)

• global bonds

  • bond that is issued in multiple markets, combines all the other types of bonds

  • would have different risks to account for the exchange rate risk

what are debt covenants?

restrictions on the bond that protects the bond holders’ debt payments

• reduces agency cost of debt as firm is restricted in the use of debt

• ex. no paying dividends, no mergers or acquisitions, maintain good stock performance, etc

covenants aren’t in the best interest of equity holders as it prevents them from generating max return via risky investments

what is the correlation of the YTM and coupon rate on price and FV of the bond?

• if the YTM = coupon rate, Price = FV

• if YTM < coupon rate, Price > FV

• if YTM > coupon rate, Price < FV