Fixed Income Investments - Other Types of Bonds
Corporate Bonds vs. Medium-term Notes
The main difference between medium-term notes and corporate bonds is the way they are issued in the marketplace. MTNs can be offered to investors by the issuer's agent instead of being underwritten by investment banks and then sold to the public in one shot.
- This helps to cover the funding gap between commercial paper and long-term bonds, hence the "medium-term" designation.
- When a firm what to issue this type of debt they have to file a "shelf registration" that lists the details of the offering, such as rates, maturities and the investment banks acting as their agent.
- It is also important to know that MTNs can also come in different structures instead of mirroring a corporate bond. These include: step up notes, inverse floaters, deleveraged floaters, range notes and index amortizing notes.
What is a Structured Note?
A synthetic medium-term debt obligation with embedded components and characteristics that adjust the risk/return profile of the security. A structured note is a hybrid security that attempts to change its profile by including additional modifying structures. A simple example would be a 5 year bond tied together with an option contract for increasing the returns. A motivation for their issuance is the fact that they allow investors to realize a profit from favorable price movements.
What is Commercial Paper?
Commercial paper is a short term unsecured promissory note that is fewer than 270 days to maturity and is issued as a zero-coupon security. Companies continue to "roll over" or pay off the holders by issuing new commercial paper in the market. The risk to investors is that the issuing company will not be able to place the new commercial paper to pay off their older debt.
Commercial Paper is issued in two ways:
- Directly Placed: The issuing company sells the paper directly to the investing public without the help of an agent or intermediary. An example would include GE Capital.
- Dealer-Placed: The issuing company uses an agent to help sell its paper in the marketplace.
Commercial paper has its own credit rating and can de divided into financial and non-financial companies.
Negotiable CDs - A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination. CDs are generally issued by commercial banks and are insured by the Federal Deposit Insurance Corporation (FDIC). The term of a CD generally ranges from one month to five years.
A certificate of deposit is a promissory note issued by a bank. It is a time deposit that restricts holders from withdrawing funds on demand. Although it is still possible to withdraw the money, this action will often incur a penalty.
For example, let's say that you purchase a $10,000 CD with an interest rate of 5% compounded annually and a term of one year. At year's end, the CD will have grown to $10,500 ($10,000 * 1.05).
CDs of less than $100,000 are called "small CDs"; CDs for more than $100,000 are called "large CDs" or "jumbo CDs". Almost all large CDs, as well as some small CDs, are negotiable.
Bankers Acceptances - A short-term credit investment created by a non-financial firm and guaranteed by a bank. Acceptances are traded at a discount from face value on the secondary market. Banker's acceptances are very similar to T-bills and are often used in money market funds.