Fixed-Income Markets for Corporate Issuers

Introduction to Corporate Funding

This module explores the various funding options available to corporations, from short-term financing for working capital needs to long-term debt for major investments. We will cover alternatives for both non-financial and financial companies.

Short-Term Funding Alternatives

Companies require short-term funding to manage day-to-day operations. These funds can be sourced from external intermediaries or directly from the market.

External Loan Financing (Bank Lending)

Type of Loan/Facility	Description	Reliability & Cost
Uncommitted Line of Credit	A flexible arrangement where a bank agrees to lend up to a certain amount, but is not obligated to do so.	Cost-effective but unreliable, as the bank can refuse to lend at its discretion.
Committed Line of Credit	A formal agreement where a bank is obligated to lend up to a specified amount.	Reliable, but typically involves upfront fees.
Revolving Credit Agreement (Revolver)	The most dependable option, allowing a company to borrow, repay, and re-borrow funds up to a credit limit as needed.	Highly reliable and flexible, but comes with commitment fees.
Secured Loans	Loans backed by specific assets as collateral (e.g., inventory, receivables). Used by companies with lower credit quality.	Provides access to funding for riskier borrowers.
Factoring	Selling accounts receivable to a third party (a "factor") at a discount to receive immediate cash.	A quick way to access cash, but can be expensive.

External, Security-Based Financing

Commercial Paper (CP) is a key tool for large, highly creditworthy companies to raise short-term funds directly from the market.

Characteristics: It is an unsecured, short-term promissory note. The market is characterized by very short maturities and low default rates.
Rollover Risk: A significant risk with CP is that a company may be unable to issue new paper to pay off maturing paper. This risk can be mitigated by maintaining backup lines of credit with banks.
Eurocommercial Paper (ECP): CP issued in the international market. This market is generally smaller and less liquid than the U.S. commercial paper (USCP) market.

Short-Term Funding for Financial Institutions

Banks have unique short-term funding needs to bridge the gap between their lending activities and their deposit base.

Deposits: Retail and commercial deposits (checking, savings, Certificates of Deposit) are a primary funding source.
Interbank Market: Banks lend to and borrow from each other to manage short-term liquidity.
Central Bank Funds: Banks can borrow from their nation's central bank.
Commercial Paper: Financial institutions are major issuers of CP.

Repurchase Agreements (Repos)

A repurchase agreement (repo) is a form of short-term, collateralized borrowing. One party sells a security to another party and agrees to buy it back at a later date for a slightly higher price. The difference between the sale price and the repurchase price represents the interest on the loan, known as the repo rate.

Key Concepts in Repo Transactions

Concept	Description
Repo vs. Reverse Repo	Repo: From the perspective of the party selling the security to borrow cash. Reverse Repo: From the perspective of the party buying the security to lend cash.
Repo Rate Factors	The repo rate is influenced by money market interest rates, the term of the repo, the quality of the collateral (safer collateral = lower rate), and the demand for the collateral.
Risk Mitigation	Haircut/Initial Margin: The lender is protected by lending slightly less cash than the collateral is worth. The difference is the haircut. Variation Margin: If the collateral's value falls, the borrower must post additional cash or collateral to maintain the required margin.

Applications and Risks

Benefits: Repos are used for financing securities, generating short-term income, implementing monetary policy (by central banks), and facilitating short selling.
Risks: Key risks include default risk, collateral risk (collateral value falling), and legal/settlement risk.

Long-Term Corporate Debt

Companies issue long-term debt to finance major projects and long-term investments. The corporate bond market is segmented by credit quality.

Investment Grade (IG) vs. High-Yield (HY) Debt

The key distinction is default risk. IG issuers have a strong capacity to meet their obligations, while HY ("junk") issuers are more vulnerable.

Feature	Investment-Grade (IG) Bonds	High-Yield (HY) Bonds
Default Risk	Low.	High. HY bonds behave more like equities due to their uncertain returns.
Yield Composition	The yield (YTM) is primarily driven by the underlying government bond yield (the risk-free rate).	The YTM includes a significant issuer-specific credit spread to compensate investors for the higher risk.
Covenants	Less restrictive.	More restrictive to provide greater protection for investors.
Market Dynamics	Issuers have more flexibility, with maturities often extending to 30 years or more. Less sensitive to economic cycles.	Maturities are typically shorter. The market is more volatile and sensitive to economic conditions.
Callable Bonds	Less common.	Common. HY issuers use call features to give them the option to redeem debt early and refinance at a lower cost if their credit quality improves.

Fallen Angels: These are bonds from issuers that were once investment grade but have been downgraded to high yield. When this happens, investors with IG-only mandates are forced to sell, which can cause the bond's price to drop significantly, especially since the HY market is smaller than the IG market.