Pondering About Corporate Debt

What is Debt:

Debt is money owed by a borrower to another. There are many categories of debt, including corporate debt.

What is Corporate Debt:

To meet financial needs that cannot be met with cash or outright payment like long-term investments, an organization or party can borrow money from another. This situation can create corporate debt. Corporate debt is not personal, it is incurred by any party such as a corporation or an organization.

Different Types of Corporate Debt:

There are many ways for a corporation to gain debt. Typically, debt is incurred through the use of debt instruments. These debt instruments can include bank loans, corporate notes and bonds, and commercial paper.

Bank Loans:

Oftentimes, a corporation will borrow money from banks, therefore incurring debt. Generally, you need good credit to be issued a loan. They are mainly two types of bank loans: bilateral loans and syndicated loans. Bilateral loans are loans issued by one individual financial institution. On the other hand, syndicated loans are loans issued by a group of financial institutions called a syndicate. Banks that are called originators are the banks that issue the loan. In bilateral loans the sole bank lending money is the originator, whereas in syndicated loans a bank that acts as lead is the originator.

Corporate Notes and Bonds:

Corporations can issue bonds, which investors can choose to invest in. The corporation then agrees to pay a prior agreement of interest payments called a coupon at a variable or fixed rate to the bondholder. After a bond reaches maturity, or expires, the corporation returns the original investment to the investor. The benefit of corporate bonds is that corporations can receive the capital it needs while the bondholder gets interest payments.

The difference between corporate notes and bonds is their maturity. Corporate notes are generally considered any bonds below 12 years of maturity, or a short-term bond (1-5 years) and intermediate-term bond (5-12 years). Corporate bonds are considered to be any bond with a maturity of more than 12 years, or a long-term bond (12+ years).

There are also different types of corporate bond options including call, put, and conversion. Callable bonds enable the bond issuer to have the ability to take the bond back before maturity. It is a valuable benefit for corporations looking to refinance a debt. Because they benefit companies, they often have a higher yield than a regular bond. In contrast, putable bonds benefit the bondholder. It allows the bondholder to sell the bond back to the issuing company if the bond’s price decreases. It can be valuable when interest rates on the rise. Because they benefit bondholders, the yield is lower than other bonds. And lastly but not least, conversion bonds allow the bondholder to convert the debt into equity.

Commercial Paper:

Commercial paper is an unsecured short-term promissory note privately placed in the public market. A corporation can benefit from issuing commercial paper as it is a cheaper source of funding for bridge financing, seasonal cash flow demand, and working capital. Generally, most issuing companies have extremely high credit quality as to avoid investors facing an issuer that cannot offer new commercial paper to pay off the existing ones. And, commercial paper has a low maturity so it is not widely traded in a secondary market.

Written by Allie Chang


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