Learning Module 4
Fixed-Income Markets for Corporate Issuers

Uncommitted bank line of credit: Least reliable; bank can refuse to honor. No upfront fee; interest only on drawn amount. Used by clients with stable deposits.

Committed (regular) line of credit: Formal written commitment; more reliable. Requires commitment fee (e.g., 0.50% on full or unused amount). Usually 364‑day to minimize bank capital requirements.

Revolving credit agreement (revolver): Most reliable; multi‑year commitment with covenants. Similar to regular lines but longer term.

Secured loans (asset‑based loans): Collateralized by receivables, inventory, or fixed assets. Used by companies with insufficient credit quality for unsecured loans.

Factoring: Selling accounts receivable to a factor at a discount; shifts credit‑granting and collection process to the factor.

Commercial paper (CP): Short‑term unsecured promissory note (typically < 3 months). Used for working capital, seasonal needs, bridge financing. Rollover risk — risk of not being able to issue new CP at maturity. Mitigated by backup liquidity lines (committed credit lines).

Eurocommercial paper (ECP): CP issued in the international market; smaller and less liquid than USCP.

Deposits: Demand deposits (checking accounts) — stable but may require liquidity reserves. Savings deposits / CDs — negotiable or non‑negotiable.

Interbank market: Unsecured borrowing/lending among banks; rates tied to MRR. Central bank funds market — banks lend reserves to meet reserve requirements; central bank funds rate is the policy rate.

Commercial paper: Financial institutions are the largest CP issuers (~60% of volume).

Asset‑backed commercial paper (ABCP): Secured by loans/receivables placed in an SPE; off‑balance‑sheet financing. Reduces bank capital costs.

A repo involves the sale of a security with a simultaneous agreement to buy it back at a future date at a pre‑agreed repurchase price.

Cash borrower (seller) receives cash; cash lender (buyer) receives collateral and interest (repo rate).

Initial margin (haircut): Collateral value exceeds cash lent. Initial margin = Security Price₀ / Purchase Price₀. Haircut = (Security Price₀ − Purchase Price₀) / Security Price₀.

Variation margin: Additional collateral (or release) to maintain initial margin when collateral value changes.

Financing ownership: Banks borrow cash to finance securities inventory; reduces funding requirement to haircut amount.

Lending cash: Investors (money market funds, pension funds) earn short‑term collateralized return; higher returns for longer terms or lower‑quality collateral.

Short selling: Hedge fund borrows security via repo, sells it short, later repurchases and returns to close repo. Profit if price falls more than repo cost.

Monetary policy: Central banks use repos to temporarily inject/withdraw reserves.

Default risk: Counterparty fails to repurchase or return collateral. Secured nature reduces but does not eliminate risk.

Collateral risk: Collateral may become illiquid or lose value; should have low correlation with counterparty credit risk.

Margining risk: Timely valuation and transfer of variation margin; adverse market conditions may cause large margin calls.

Legal risk: Enforceability of rights under repo agreement.

Netting and settlement risk: Ability to offset obligations and take possession of collateral.

Bilateral vs. triparty repo: Triparty uses a custodian/clearinghouse for valuation, collateral management, and safekeeping.

Both issuers and investors weigh maturity choices: longer maturities offer higher yields but expose investors to price risk (if sold before maturity) and issuers to rollover risk (if refinancing at higher rates).

Under normal conditions, longer maturities have higher interest rates and higher credit spreads for a given issuer.

Fallen angels: Formerly IG issuers that have been downgraded. Their outstanding debt retains IG features (non‑callable, few covenants, longer maturities) but trades at HY spreads.

Callable debt: HY issuers often issue callable bonds to retain flexibility; if credit improves, they can refinance. Investors' gains are capped at the call price.