Non-sovereign bonds are bonds issued by the local governments such as states, provinces, and cities, and not by the national government. The characteristics of non-sovereign bonds are as follows:
Quasi-government bonds are bonds issued by non-government entities, but they are usually backed by the government. The characteristics of these bonds are as follows:
Supranational bonds are bonds issued by international organizations such as the World Bank, IMF, EIB, ADB, etc. They are usually plain-vanilla bonds. Sometimes callable or floaters are also issued.
We now shift our focus from sovereign debt to corporate debt. Companies borrow primarily from banks and only 30% of their financing needs come from the financial markets.
There are two types of bank loans: bilateral and syndicated.
Most bilateral and syndicated loans are floating-rate loans, linked to a reference rate such as Libor. For highly rated companies, both bilateral and syndicated loans can be more expensive than bonds issued in financial markets.
A commercial paper is a flexible, readily available, and low-cost instrument issued by companies to meet their short-term needs. They are issued for a short period, typically between 15 days and one year.
A commercial paper may be regarded as the corporate equivalent of a T-bill because it is short-term in nature. In a CP, since companies may borrow directly from the market, the cost of borrowing is less than that of banks.
Companies use commercial paper:
The characteristics of a commercial paper are as follows:
US Commercial Paper vs. Eurocommercial Paper
The US commercial paper (USCP) market is the largest commercial paper market in the world. Commercial paper issued in the international market is known as Eurocommercial paper (ECP). The differences between the two are summarized in the table below:
|USCP vs. ECP|
|Feature||US Commercial Paper||Eurocommercial Paper|
|Currency||U.S. dollar||Any currency|
|Maturity||Overnight to 270 days||Overnight to 364 days|
|Interest||Discount basis||Interest-bearing basis|
|Settlement||T+0 (trade date)||T+2 (trade date plus two days)|
|Negotiable||Can be sold to another party||Can be sold to another party|
The key difference between a USCP and ECP is in the way interest is paid. USCP, like a zero bond, is sold at a discount. The par value is paid on maturity. ECP, on the other hand, is sold at par and the interest is paid along with the par value at maturity. The example below illustrates this difference for a $100 million CP issued at 4% for 90 days.
|$100 million, 90-day at 4% commercial paper|
|USCP: issued by U.S. Bank||ECP: issued by a French company|
|Interest:||100,000,000 x 0.04 x 90/360
|100,000,000 x 0.04 x 90/360
|At issuance, money received by bank/company||Interest discounted from par:
100,000,000 – 1,000,000=$99,000,000
|Par value: $100,000,000|
|Bank/company pays at maturity:||Par value = $100,000,000||Par value + interest = 10,000,000 + 1,000,000 = $101,000,000|
|Return on investment for 90 days||1,000,000/99,000,000 = 1.01%||1,000,000/100,000,000 = 1.00%|
Corporate bonds may be categorized based on several characteristics such as maturities, coupon payment structures, and contingency provisions that we will discuss in this section.
Short-term, medium-term, long-term: There is no formal categorization of what constitutes a short-term, medium-term, and long-term security. But we will go with the classification below based on common practice.
|Classification of Corporate Bonds Based on Maturity|
|Original maturity||Term||What are they called?|
|Five years or less than five years (≤ 5)||Short-term||Notes|
|Greater than 5 and less than 12 years
(> 5 and ≤ 12)
|Greater than 12 years (> 12)||Long-term||Bonds|
Medium-term note (MTN): The term ‘medium’ in an MTN is a misnomer because the maturities range from 2 years to greater than 30 years.
Coupon Payment Structures
Coupon payments for corporate notes and bonds vary based on the type of bond:
Note: We have seen most of these in the previous reading, so we will just skim through them
Principal Repayment Structures
Broadly speaking there are three types of principal repayment structures. These are outlined below:
Asset or Collateral Backing
Unlike highly-rated sovereign bonds that carry almost no default risk, all corporate bonds have varying amounts of default risk. The objective of asset or collateral backing is to protect investors in the event of a default. Secured debt, i.e., debt backed by collateral, is not completely insulated from losses, but it is considered better than unsecured debt.
Contingency provisions are clauses defined in a bond’s indenture to protect the bondholders. These provisions specify under what conditions a bond may be redeemed or paid-off before maturity. Some provisions benefit the issuer while some benefit the investor. The three contingency provisions are call provision, put provision, and a convertible bond.
Issuance, Trading, and Settlement
Major points with respect to issuance, trading, and settlement are given below: