WORLDCOM, INC.: CORPORATE BOND ISSUANCE
Teresa Santos Mazo
Pablo Martínez Menarguez
Carlos José García-Ordóñez Moreno
María Lopez Orero
Íñigo Ezcurra Oyarbide
Carlos Arturo Rey Patiño
Ana Pons Pelufo
Antonio García-Pumarino Pérez
Ricardo Andrés Moya Pico
Alejandro Longueira RamírezHow does financing with corporate bonds typically differ from a bank loan?
A corporate bond is a type of bond issued by a corporation. It often pays a higher interest rate than government or municipal bonds, because it tends to be riskier. Bond prices reflect the changes in interest rates due to their risk. One of the defining features of corporate bonds is that they carry moredefault risk than many other types of bonds.
A bank loan is a loan made by a bank. The borrower obtains a sum of money from the bank, and it agrees with it to repay the borrowed amount, which is called principal, plus a lower amount charged for the use of the money, which receives the name of interests. That process has to be done at a specified date in the future.
Companies requireshort-term, medium term and long term debt in order to carry their day-to-day activities and undertake investments that could result in an increase in production. A company needs short-term loans in order to meet its working capital requirements. Working capital is needed for operations such as making payments to suppliers, paying wages and salaries and so on. Investments such as buying land andequipment, investing in research and development and incurring other expenses which are usually capitalized require medium and long term debt.
The choice of whether to borrow money from the bank or raise money by issuing bonds depends on a number of factors.
Credit Quality of the Borrower. It determines the type of debt preferred by the borrower or the kind of debt that can easilybe accessed by the company. Borrowers with medium credit quality generally prefer bank loans. Bonds issued by such borrowers carry a higher rate of interest than the interest on bank loans. This is because the bondholder´s claim is subordinate to the bank´s claim. In case of default, the bank has prior claim on the assets of the company. A medium to poor credit quality ensures that the borrowerturns to bank loans.
Line of credit. The line of credit has a revolving credit card structure which means that the business firm is expected to pay off only the minimum interest that accrues on its loans. A line of credit is useful for the business to meet its working capital requirements. Generally, the collateral for the line of credit is the firm´s inventory or its receivables. Unlikethe line of credit, a bond provides a lump sum amount to the issuer and the interest is charged on the entire amount sanctioned.
Emerging Market Country Premiums. Interest rate on bonds includes a huge country risk premium for companies located in emerging markets. This is because of the inflation and political and economic instability characteristic of the emerging economies. Suchcompanies generally issue junk bonds that carry a high rate of interest. On the other hand, bank loans are a better instrument for firms located in those countries because restructuring foreign bank loans is easier compared to restructuring bonds that have a long maturity period. The liquidation of a bank loan is easier. In addition, banks charge, in general, lower country risk premium than those typicalof bondholders.
Covenants. Covenants define the obligations and rights of the borrower. Any bond carries both positive and negative covenants. Positive covenants are the rights of the borrower whereas negative covenants are the restrictions imposed upon him. The restrictions may be related to incurring additional debt or selling off certain assets. Banks in general impose greater...