7_other_securities

Other Securities

Corporate Bonds

• Definition: Corporate debt instruments are financial obligations of a corporation that have priority over its common stock and preferred stock in the case of bankruptcy.

• Types of Corporate Debt Instruments:

  1. Corporate Bonds

  2. Medium-Term Notes

  3. Commercial Paper

  4. Bank Loans

  5. Convertible Corporate Bonds

  6. Asset-Backed Securities

Classification of Corporate Bonds

• Sector Classifications:

  1. Utilities: Companies involved in the generation, transmission, and distribution of electric, gas, and water.

  2. Financials: Bonds from a wide range of financial institutions such as banks, insurance companies, and mortgage firms.

  3. Industrials: Corporates not classified as utilities or financials.

• Credit Risk Classifications: Based on credit ratings assigned by major credit rating agencies.

  • Investment-Grade: Denotes lower credit risk.

  • Non-Investment-Grade (High-Yield Debt Obligations): Higher credit risk.

Debt Seniority in a Corporation’s Capital Structure

• Capital Structure: Comprises common stock, preferred stock, and debt.

• Debt Priority:

  1. Senior Secured Debt

  2. Senior Unsecured Debt

  3. Senior Subordinated Debt

  4. Subordinated Debt

Secured vs Unsecured Debt

Senior Secured Debt

• Definition: Backed by collateral such as real estate or personal property.

• Mortgage: Grants creditor a lien against pledged assets. Means the creditor can sell property if the borrower defaults on the loan, ensuring recovery of funds.

Senior Unsecured Debt

• Pledge stocks notes, bonds or other kinds of assets

Unsecured Debt

• Definition: Not specifically secured by collateral but may have claims on issuer's assets.

• Debenture Bonds: Another name for unsecured bonds.

Subordinated Debt

• Definition: Ranks after senior secured and unsecured creditors. Some subordinated creditors may have priority relative to other subordinated holders.

Bankruptcy and Creditor Rights

• Priority in Bankruptcy: Holders of corporate debt instruments have priority over equity owners.

• Bankruptcy Law Functions: Establishes rules for liquidation or reorganization of a corporation; allows debtors to formulate a repayment plan.

Liquidation and Reorganization Process

• Liquidation: All assets distributed to creditors; corporation ceases to exist.

• Reorganization: Corporate entity continues but may be altered; creditors may receive cash, new securities, or both.

• Protective Measures: Bankruptcy act grants corporations time to determine reorganization or liquidation plan.

Bankruptcy Chapters

• Key Chapters:

  • Chapter 7: Liquidation of a company.

  • Chapter 11: Reorganization of a company; interest and principal payments are suspended upon filing.

• Absolute Priority Rule: Senior creditors are paid in full before junior creditors receive any asset distributions.

Credit Ratings and Corporate Debt

• Credit Analysis: Conducted by professional managers to estimate issuer's ability to meet obligations.

• NRSROs: Nationally Recognized Statistical Rating Organizations that assign credit ratings (e.g., Moody’s, S&P, Fitch).

• Rating Categories:

  • High Grade (Aaa, AAA, Aa, AA)

  • Investment-Grade (A, BBB, Baa)

  • Non-Investment-Grade (Junk Debt): Ratings below BBB.

Historical Context: Financial Crisis and Ratings Probleme

• Credit ratings faced scrutiny due to overestimation of safety, particularly for mortgage-backed securities during the 2007-2009 crisis.

Corporate Bonds Characteristics

• Term Bonds: Payable after a specified term.

• Notes: Under 10 years maturity.

• Bonds: Typically 20-30 years.

• Serial Bonds: Principal amounts due on specified dates.

accrued inerest. however much interest has accrued since the last coupon payemnt

Callable Bonds

• Definition: Bonds with a call provision allowing issuers to buy back securities before maturity.

• Call Price: Price for retiring the bond, sometimes includes deferment periods.

Make whole call provision. Must pay back present value of all coupon payments and terminal value

Sinking Fund Requirements

• Definition: Requires issuer to retire a portion of the bond issue periodically.

• Purpose: To reduce credit risk and may involve provisions for retiring larger amounts.

Corporate Bond Yield Calculations

• Accrued Interest Calculation: Based on a 30/360 convention for time periods (e.g., one-third of a coupon per day).

Bank Loans Classification

• Investment-Grade Loans: Given to borrowers with investment-grade ratings.

• Leveraged Loans: Issued to corporations with non-investment-grade ratings.

Syndicated Bank Loans

• Definition: Loans from a syndicate of banks for large financing needs, typically with varying interest rates based on a reference rate.

Collateralized Loan Obligations (CLO)

• Definition: Pooling of leveraged loans as collateral for issued debt and equity.

• Capital Structure: Organized into various risk-labeled bond classes with floating rates.

Municipal Bonds Overview

• Definition: Bonds issued by state and local governments; attractive due to positive tax treatment.

• Types:

  1. Tax-Backed Bonds: Secured by tax revenue.

  2. Revenue Bonds: Pledged revenues from operational projects.

Bondholder Risks**

• Tax Risk: Decline in federal tax rates affects value, and IRS reclassification might render bonds taxable.

• Yield Comparison: Tax-exempt municipal bonds often yield less than taxable bonds; the equivalent taxable yield is computed for comparison.

International Bonds**

• Market Classifications: Developed, Emerging, and Frontier capital markets.

• Yield Comparisons: Differentiation between yields in U.S. and Eurobond markets.