US Debt

Market
Adam Alexander Lin Jordan (A0179379E)
Jaime Lee Si Ying (A0142759W)
Philipp Zinnenlauf (A0179131H)
Yeong Hui Qing Samantha (A0143279Y)

Corporate Debt Market - Corporate Debt Market - Government Debt Market -

Overview Investors’ Point of View
Public Debt Private Debt Public Debt
Agenda

● Overview of Corporate and Government Debt Market

● Corporate Debt Market - Public debt securities
○ Commercial Paper
○ Corporate Bonds
● Corporate Debt Market - Private debt securities
○ Personal loans
○ Mortgages
○ PE and Venture Capitalist Financing
● Government Debt Market
○ US Treasury Securities
○ Municipal Bonds
● Investor’s Point of View

Corporate Debt Market - Corporate Debt Market - Government Debt Market -

Overview Investors’ Point of View
Public Debt Private Debt Public Debt
US Debt Market - Definitions

Players Public Debt Private Debt

Securities
● Securities
●
● ●

● Federal ● Traded publicly ● Acquired solely

Government on a market between the
● Local ● Government Debt lender and
Government Market borrower
● Corporations ● Corporate Debt ● Mainly in the
Market Corporate Debt
Market

Overview
 History of US Debt Market

1st Bull Market 2nd Bull Market

21st Century 2017
(after WWI to after WWII) (1970s)

20th Century: Equity 1970s: Globalisation New derivatives to Size of US debt

Holders > Debt Holders hedge market ($39 trillion)
More asset classes outweighed US Stock
US Government kept bond created → US bond market to market by $12 trillion
yields low although maintain their
inflation rate was high dominance

After restrictions removed,

bond yields increased

Corporate bonds: higher

default risk, higher yields

Overview
US Debt Market

Issuance of Bonds
● Larger growth in the issuance of bonds
in the corporate debt market
● Greater volatility in the corporate debt
market

Outstanding Bonds
● Generally increasing at a constant rate
● 2017: fall in number of outstanding bonds

Overview
 Commercial Paper (CP)
● CP are issued to finance accounts receivable, inventory and other short term debt obligations
● Agreement between corporations: Multinational Enterprises and Financial Institutions (Issuer) and Money Market
Mutual funds and Insurance companies (Investor / Holder)
Market volume tripled
- Maturity: Average 30 days, but no longer than 270 days
(Figure 2)
→ Part of Money Market and no registration of issuance with SEC
Characteristics: → Cost and Time saving effects for issuer
Characteris
- Low default risk
tics: - Unsecured promissory note: Backed only by reputation of issuer
- Short maturity (<270
days)
- Low cost alternative to bank loans: Return on CP smaller than the bank - Increased need of
prime rate funds to hold liquid,
Advantages: short-term and high
- Issued by the largest & most creditworthy firms:
→ High credit rating and short maturity → CP low risk investment quality assets

(Figure 1) Return on CP (Figure 2) Volume of CP Outstanding

Corporate Debt Market -

Public Debt
Process of CP Issuance

Understand Potential
Issuers Reasons Number of dealers
Investors

1. Greater Flexibility of Each investor faces

40 % of securities in CP
funding paper market are sold
different restrictions:
by dealers
1. Amount of CP can
More diversified be bought
fund-raising strategy 2. Minimum rating Responsible for building
allowed to invest in investor relationships
Access to higher 3. Name recognition → Number depends on
variety of investors the markets a company
intends to enter
Target investors and
Decreasing counterparty their requirements: Strategy of CP program
related risks 1. High Liquidity 1. Size of CP Program
2. 2. High Security 2. Credit Ratings as
Cheaper and faster 3. Yield key driver to access
financing method Expectations respective investors

Corporate Debt Market - Corporate Debt Market -

Public Debt Private Debt
Corporate Bonds - allows borrowing for a longer time period
1. Restrictive Covenants in the bond indenture:
a. Aim: Protect bondholders’ interests → Ensure sufficient cash on hand for interest payments
b. Extend of rules: Limitations on dividend payouts, additional debt issuance and involvement in M&A
activities.

2. Call provision:
a. Aim: Increase company's flexibility
b. Reasons to include feature:
i. Interest rate → Bond price : If rates fall enough, the bond price will rise above the call price
ii. Restrictions by Covenants: Retirement of bonds when activity that is in interest of shareholder not in
line with rules
iii. Change in Capital Structure: Mature firms with excess CF may wish to reduce debt load, if not
enough attractive investment opportunities are available

3. Conversion Feature:
a. Aim: Convert Corporate Bonds into common shares → Allow shares in good times when bond price
b. Reasons to include feature:
i. Avoid sending out a negative signals by additional stock issuance
→ Managers believe in good future performance: Issue convertible bonds

Corporate Debt Market -

Public Debt
Classification and Advantages of Corporate Bonds

Classification of corporate bonds: Advantages of Corporate Debt over:

- Debt restrictions are more tailored

1. Bank loans to firm’s specific business risk
→ Borrow from bank more
restrictive (Lender of last resort)

Bank loans - Corporate Debt does not signify

ownership interest
2. Equity - Better forecasting availability:
Principal value & obligations known
and no claim on future profits

(Figure 3)
Overall
amount of
stocks and
bonds issued

Corporate Debt Market -

Public Debt
Personal Loans

● Any loans between a private lender and an individual

● Secured or unsecured

● Requires collateral
Secured Loans ● When the borrower defaults → lender → Individual’s
becomes the rightful owner of the collateral credit rating is
more important for
● Do not require collateral unsecured loans
Unsecured Loans ● When the borrower defaults → lender does (higher risks)
not gain anything

Corporate Debt Market -

Private Debt
Mortgages

● Long term loans to individuals, with real estate as a collateral

● Fixed rate and adjustable rate mortgages

Fixed Rate: Same interest rate for the entire period of the loan

Adjustable Rate: Interest rate change over time according to a pre-determined index

Corporate Debt Market -

Private Debt
Case Study 1: US Sub-Prime Crisis

● Homeowners with credit rating ≤ 640 qualified for subprime mortgages

● In 2006, home prices fell, homeowners could not afford mortgage payments
● Interest rates increased → Adjustable Rate Mortgages increased
● Defaults skyrocketed
● Banks did not want to lend to other banks
● Bank failure
● Shows how unregulated mortgages led to financial crisis

Corporate Debt Market -

Private Debt
Private Equity and Venture Capitalists Financing

Private Equity Venture Capitalists

Buy over a large Invest in startups

stake of a mature, that require capital
stagnated for growth
company’s equity

Use debt financing to raise capital for investment

● Borrow from private banks

● Lower risk credit rating than the individual ventures

Corporate Debt Market -

Private Debt
Government Bonds

● As of 2018, the US
government debt is over USD
20.1 trillion
● More than ⅔ of it is public
debt, and ⅓ of it being
intragovernmental debt

Government Debt Market -

Public Debt
Source of Government Borrowing

Occurs when trust accounts has surplus

Borrowing from ● Treasury borrows from FA to pay off debt
Federal
● Borrowed fund has to be paid back by Treasury at later date
Accounts
● Intragovernmental debt

Three Countries that hold the largest US debt are:

● China (US$1.2 trillion), Japan (US$1.1 trillion) and Ireland
Borrowing from (US$326 billion)
Other Countries
● Countries buy treasury securities to keep their currency at a
competitive value

Government Debt Market -

Public Debt
Causes of Government Debt

Programs
implemented by Military Spending
Presidents

President Obama’s
American Recovery Afghanistan war
and Reinvestment costing $1trn and the
Act (ARRA) and tax Iraq war costing
cuts, adding $7.91 $807.5bn
trillion a year.

Government Debt Market -

Public Debt
US Treasury Securities

T-Bills, T-Notes, Floating Rate

TIPS STRIPS
T-Bonds Notes

Difference in maturities Interest payment TIPS: Treasury Separate Trading of

● T-Bills is the changes depending on Inflation-Protected Registered Interest
shortest with the current interest rate Securities and Principal of
maturity of 4
Securities (STRIPS)
weeks
● T-Bonds has the
Principal adjusts
maturity of 30 Zero coupon
years accordingly during
inflation or deflation securities, with
payment only at
maturity

Government Debt Market -

Public Debt
Municipal Bonds

● Municipal bond market is currently valued at US$3.8 trillion

Characteristics: ● Issued to raise funds for state projects

● Federal tax exempted and mostly state tax exempted too

● New tax bill passed: $10,000 cap on state and local taxes deducted
Advantages:
● Low risk (default on munis are lower than corporate bonds of similar
ratings)

Government Debt Market -

Public Debt
Case Study 2: Great Bond Massacre (1994)

● Fed raised interest rates to 2.25% in 1994

● Increase in US 30-year bond yield to 7.75%
● Sharp drop in bond prices
● Sellout of bond market
● Global decline in bond value of US$1.5 trillion
● Currently, long-term rates has been decreasing
while short-term rates are increasing

→ Reflects investors’ loss of confidence in Fed and

overall health of economy

Government Debt Market -

Public Debt
Investors’ Point of View

● Long-term rates are decreasing while short term rates are increasing
● Could lead to an inverted yield curve
● Poses a concern for investors

Investors’ Point of View

Investors’ Point of View

● Speculation that another Great Bond Massacre may be happening

● Demand for treasury securities are expected to rise or maintain
○ Purchasing of treasury securities by foreign countries
○ Economic uncertainty in European Union
● Corporate, public debt securities expected to rise
○ Corporate bonds have greater flexibility than bank loans

Investors’ Point of View

 Conclusion

Corporate Debt Market - Corporate Debt Market - Government Debt Market -

Overview Investors’ Point of View
Public Debt Private Debt Public Debt