Coupon Rates Research Articles

Optimal restructuring strategies under various dynamic factors

Corporate restructuring was identified as a new industrial force that has great impact on economic values and that therefore has become central in daily financial decision making. This article investigates the optimal restructuring strategies under different dynamic factors and their numerous impacts on firm value. The concept of quasi-leverage is introduced and valuation models are built for corporate debt and equity under imperfect market conditions. The model’s input variables include the quasi-leverage and other firm-specific parameters, the output variables include multiple corporate security values. The restructuring cost is formulated in the form of exponential function, which allows us to observe the sensitivity of the variation in security values. The unified model and its analytical solution developed in this research allow us to examine the continuous changes of security values by dynamically changing the coupon rates, riskless interest rate, bankruptcy cost, quasi-leverage, personal tax rate, corporate taxes rate, transaction cost, firm risk, etc., so that the solutions provide useful guidance for financing and restructuring decisions.

Pricing American options for interest rate caps and coupon bonds in quantum finance

American option for interest rate caps and coupon bonds are analyzed in the formalism of quantum finance. Calendar time and future time are discretized to yield a lattice field theory of interest rates that provides an efficient numerical algorithm for evaluating the price of American options. The algorithm is shown to hold over a wide range of strike prices and coupon rates. All the theoretical constraints that American options have to obey are shown to hold for the numerical prices of American interest rate caps and coupon bond options. Non-trivial correlation between the different interest rates are efficiently incorporated in the numerical algorithm. New inequalities are conjectured, based on the results of the numerical study, for American options on interest rate instruments.

The Development of the Brazilian Bond Market

The bond market represents a large proportion of the GDP in developed countries but it seems to be underdeveloped in emerging markets. In the particular case of Brazil, it is widely known that firms do not have access to enough credit at a reasonable cost. Our goal is to provide a better understanding of the current state of the Brazilian bond market and provide suggestions to promote its development. We focus on the main types of corporate debt, especially domestic bonds, bank loans, international bonds, suppliers, and asset-backed securities. Most domestic bonds are non-convertible, subordinated, and have floating or inflation-indexed coupon rates. Except for international bonds and foreign banks, most financial liabilities are not denominated in foreign currency. Bond financing is positively related to the tangibility of assets and to firm size and negatively associated with the ROA. Firms that have bank loans tend to issue fewer domestic bonds, indicating that domestic bonds are used as an alternative to bank loans. However, firms issuing international bonds also use domestic bonds more often. Furthermore, international bonds are used as an alternative to asset-backed securities. In the case of exporters, they are able to finance through asset-backed securities using the export flow as collateral. There is also evidence that firms with good corporate governance practices issue more international bonds. Our survey results indicate that the greatest problem are the low liquidity of the secondary market, low market capitalization, low quality of legal recourse in the event of default and the absence of a complete benchmark yield curve. The main problems to finance in the domestic market are high interest rates, short maturities, and collateral requirements. We present a wealth of information on the Brazilian bond market, its development, characteristics, legal background, and structure and discuss many of the problems pointed out in our survey results along with recent initiatives to address them as well as our own suggestions for improvement.

Callable Risky Perpetual Debt with Protection Period

Issuances in the USD 260 Bn global market of perpetual risky debt are often motivated by capital requirements for financial institutions. We analyze callable risky perpetual debt emphasizing an initial protection ('grace') period before the debt may be called. The total market value of debt including the call option is expressed as a portfolio of perpetual debt and barrier options with a time dependent barrier. We also analyze how an issuer's optimal bankruptcy decision is affected by the existence of the call option by using closed-form approximations. The model quantifies the increased coupon and the decreased initial bankruptcy level caused by the embedded option. Examples indicate that our closed form model produces reasonably precise coupon rates compared to numerical solutions. The credit-spread produced by our model is in a realistic order of magnitude compared to market data.

Estimating and Interpreting Zero Coupon and Forward Rates: Australia, 1992-2001

This paper presents estimates of zero coupon yield curve of Australian treasuries. Pure discount bonds and implied forward rates, although not available for the entire yield curve, are extremely useful for pricing, modelling and analyzing financial securities, hence, the need to extract the theoretical yield curve from noisy prices observed in the market place. Two popular models for curve fitting: the Nelson-Siegel and Svensson model, together with two specifications are adopted for estimating zero coupon and forward yield rates. The six parameter Svensson's model outperforms the more parsimonious Nelson-Siegel four parameter functional form. A structural break is detected in the zero coupon time series in the test period.

Dynamic Capital Structure with Callable Debt and Debt Renegotiations

We consider a dynamic model of the capital structure of a firm with callable debt that takes into account that equity holders and debt holders have a common interest in restructuring the firm's capital structure in order to avoid bankruptcy costs. Far away from the bankruptcy threat the equity holders use the call feature of the debt to replace the existing debt in order to increase the tax advantage to debt. When the bankruptcy threat is imminent, the equity holders propose a restructuring of the existing debt in order to avoid bankruptcy. This proposal makes both debt holders and equity holders better off and re-optimize the firm's capital structure. Both the lower and upper restructuring boundaries are derived endogenously by the equity holders' incentive compatibility constraints. Our way of renegotiating the debt when the bankruptcy treat is imminent is different from the way the coupons of the debt is renegotiated in the the strategic debt service models of, e.g., Anderson and Sundaresan (1996) and Mella-Barral and Perraudin (1997). In our model the entire debt (principal as well as all future coupon rates) is restructured. It is not just the current coupon payment which is fine tuned. An important part of the debt renegotiation is to derive endogenously the value of debt and equity if the debt restructuring proposal is rejected since this determines the relative bargaining power between the two parties. However, since these values are off the equilibrium path, they have to be derived by an iterative procedure. Our model offers a rational explanation for violations of the absolute priority rule. In equilibrium the debt holders do accept a restructuring proposal from the equity holders which leaves some value to the equity holders even though the debt holders do not get their full principal back. The reason why the debt holders do accept such a proposal is that the alternative if they reject the equity holders' proposal is not necessarily an immediate liquidation of the firm. In most cases the equity holders would continue to pay the existing coupons until the conditions become even worse before eventually withholding the coupons and de facto forcing the firm into bankruptcy. Since the value of the debt in this alternative situation is lower than the value the debt holders get if they accept the equity holders' proposal, they are willing to accept the proposal even though the equity holders also get a piece of the pie. We also find that the firm's objective function is fairly flat over a large area so the capital structure of the firm can vary a lot without any significant costs or losses to the firm's stake holders. We investigate how firm value, equity value, debt value, par coupon rates, leverage, and yield spreads change in a static comparative analysis. Our results show that optimal leverage is inversely related to both growth options and earnings risk.

The Effects of Securitization on Consumer Mortgage Costs

We examine the effects of securitization on two dimensions of consumer mortgage costs: coupon rates and loan origination fees. We find no evidence that securitization reduces the coupon rates on fixed‐ or adjustable‐rate mortgages. Instead, securitization appears to lower mortgage loan origination fees, resulting in substantial savings for consumers. Securitization activity includes passthrough creation and collateralized mortgage obligation (CMO) creation. We test for differences between the effects of passthrough and CMO creation on primary mortgage costs. Surprisingly, these activities appear to have indistinguishable effects on loan rates and origination fees, suggesting that a large derivatives market for mortgage loans is not creating value for consumers.

The Effects of Securitization on Consumer Mortgage Costs

We examine the effects of securitization on two dimensions of consumer mortgage costs: coupon rates and loan origination fees. We find no evidence that securitization reduces the coupon rates on fixed or adjustable-rate mortgages. Instead, securitization appears to lower mortgage loan origination fees, resulting in substantial savings for consumers. Securitization activity includes passthrough creation and collateralized mortgage obligation (CMO) creation. We test for differences between the effects of passthrough and CMO creation on primary mortgage costs. Surprisingly, these activities appear to have indistinguishable effects on loan rates and origination fees, suggesting a large derivatives market for mortgage loans isn't creating value for consumers.

Mortgage Refinances, Streamlines and Adverse Selection

The call and default options of mortgage borrowers interact in ways that must be accounted for in both the pricing of mortgages (or equivalently the setting of mortgage coupon rates relative to Treasury coupons), the pricing of default insurance, and empirical explanations of mortgage terminations. The call option of FHA borrowers was considerably enhanced in the early 1980s with a significant reduction in the cost of streamline refinancing (limited documentation, no required appraisal, etc.). This enhancement reduced the value of the default option of FHA borrowers. We provide evidence of the negative impact of regular (nonstreamline) refinancing on the average quality of FHA?s surviving business. We demonstrate this adverse selection both informally and econometrically. We also argue that FHA?s streamline refinance program has likely reduced the level of adverse selection in the FHA portfolio and provide quantitative estimates of the potential gain from this reduction.

Equilibrium Models in Real Estate Research: A Survey

Equilibrium analysis is a valuable tool in real estate investment research. In this survey, I show how equilibrium models have been used to estimate the required risk premium for different classes of real estate, to explain real house prices, and to determine investment rental market adjustment and valuation (as well as to predict future rent, price, and value developments). Equilibrium analysis has also increased our understanding of differences in coupon or rental rates on loans or leases with and without various optionlike features. Because the work on leases has lagged that on loans or mortgages, application of the mortgage research methodology to leases is an especially fertile area for research.

Equilibrium Models in Real Estate Research: A Survey*

Equilibrium analysis is a valuable tool in real estate investment research. In this survey, I show how equilibrium models have been used to estimate the required risk premium for different classes of real estate, to explain real house prices, and to determine investment rental market adjustment and valuation (as well as to predict future rent, price, and value developments). Equilibrium analysis has also increased our understanding of differences in coupon or rental rates on loans or leases with and without various optionlike features. Because the work on leases has lagged that on loans or mortgages, application of the mortgage research methodology to leases is an especially fertile area for research.

The benchmark issue premium in the Japanese government bond market: A re-examination

This article examines whether or not a benchmark issue premium has existed in the Japanese government bond market. If the premium exists, a benchmark issue is less discounted than a non-benchmark issue, which only differ in their coupon rates. We show that, if the benchmark issue premium does not exist, then their prices are cointegrated, with cointegrating vector (1,− c), where c denotes the ratio of their coupon rates. Examining this condition, we find that, while a benchmark issue premium may have existed in past, it disappears recent periods.

Defaults of Original Issue High-Yield Convertible Bonds

The success in marketing original issue high-yield bonds has generated significant interest in their default experience. Studies comparing defaults to the par value of outstanding issues such as Altman (1987), Altman and Nammacher (1985), and Weinstein (1987) have found relatively low default rates. However, these studies understate default rates because of the rapid increase in the par value of outstanding issues and because cumulative default rates increase with years from issuance. Two recent studies by Altman (1989) and Asquith, Mullins and Wolff (AMW) (1989) have corrected these problems by using aging analysis to follow rated nonconvertible high-yield bonds over time; they find cumulative default rates for such bonds 10 years after issuance exceeding 30 percent. ; This study extends the literature on high-yield default rates to convertible and nonrated securities, not examined in previous studies. The high-yield market can be partitioned into rated nonconvertible, rated convertible, nonrated nonconvertible, and nonrated convertible securities. Other things equal, one would expect higher default risk to be associated with higher yields; however, other things are not equal. For example, securities may have high yields because of differences in liquidity or differences in conversion options. Therefore, yields reflect more than just expected default risk; they also incorporate premiums for other characteristics of individual securities. ; When the securities are partitioned by rating and convertibility, the results of this paper show that the cumulative default rates are lower for rated convertible securities than for rated nonconvertible securities. Because investors value convertibility, convertible bonds carry substantially lower coupon rates than nonconvertible bonds. These lower coupon rates may reduce the likelihood of an issue defaulting. ; In addition, this study examines nonrated securities. Many securities are nonrated because the graduated fee structure charged by rating agencies makes ratings prohibitively expensive for smaller issues. Despite some potential biases that are discussed below, the default rate on nonrated convertible bonds is significantly less than that of rated nonconvertible securities, and the default rate on nonrated nonconvertible bonds appears to be less than that for rated nonconvertible securities. ; The next section of the paper discusses the data and shows that the default rates for rated nonconvertible securities are higher than those for rated convertible, nonrated convertible, and nonrated nonconvertible securities. Each category of security is further examined for explanations for lower default rates, in Sections II through IV. Section V estimates a logit model that shows that default differences based on security characteristics persist even after controlling for coupon rates and size. Section VI summarizes the results.

Defaults of Original Issue High‐Yield Convertible Bonds

ABSTRACTRecent studies using aging analysis have found high rates of default for rated, nonconvertible high‐yield bonds. This paper examines the remainder of the market and concludes that rated and nonrated convertible high‐yield bonds had significantly lower default rates. It also provides some evidence that nonrated, nonconvertible securities may have lower default rates. Even after controlling for issue size and coupon rates in a logit model, these differences remain statistically significant.

Corporate Compliance with Debt Covenants

In this paper, I present and test a model of corporate compliance with the debt covenant requiring payment of a current obligation. This study adds to the empirical literature on forecasting financial distress by showing conditions under which debt default may be a rational economic decision by the firm's shareholders. This analysis departs from empirical financial distress studies which are often not linked to an underlying economic theory. The focus on covenant default also extends the literature which has modeled bankruptcy (Bulow and Shoven [1978]) and liquidation decisions (Titman [1984]) but which has not considered a common first symptom of financial distress-covenant default. Briefly, the model examines the costs that influence shareholders' decision to comply with or violate a particular debt covenant: payment of a current obligation. These costs include those associated with bondholders' reaction to possible default. The model predicts that shareholders will default when, holding other factors constant, (i) interest rates have declined relative to coupon rates stated in the debt issue; (ii) the probability of paying future obligations is high; and (iii) the cost of obtaining funds to pay the obligation is high. The model also predicts when stockholders and bondholders will renegotiate the debt contract and the amount of wealth transferred in the renegotiation. Finally, the

Integration of mortgage and capital markets and the accumulation of residential capital

The securitization of fixed-rate mortgages suggests that the FHA/VA market was fully integrated with capital markets by the early 1980s and that the conventional market moved toward integration during the 1980s. Assuming full integration of FHA/VAs via the GNMA securitization process, we first estimate equations explaining near-par GNMA prices weekly for the 1981-88 period. The price is then set equal to the new-issue price and, based upon the preferred equation, the perfect-market retail coupon rate is computed. Next we estimate equations (for three-year segments of the 1971-88 period) explaining conventional commitment mortgage coupon rates in terms of current and lagged values of this perfect-market coupon rate. Finally, we examine differences between the perfect-market and actual coupon rates and compute the impact of these differences on residential capital accumulation.

THE COST OF HIGH‐YIELD BOND FINANCING

In this paper, we present a model to determine the interest cost of high‐yield (HY) bond financing. We first denmonstrate that, with a relatively high coupon rate, HY bonds have a significantly higher call risk than investment‐grade bonds, and the effective life of the bond is closer to the call deferment period. Consequently, the interest cost is more affected by the duration measure than by the years to maturity, or the call feature. Furthermore, the HY bond market is segmented by the purpose of the proceeds. The interest cost is, on average, 27 basis points higher if the fund is used to finance takeover activities. The third difference we show is that firms have to pay 11 basis points more in interest costs for every additional 1 million HY bond financing. We attribute this exception to the expected illiquidity of large‐issue HY bond in the secondary market when default risk premium increases. Furthermore, the HY bond interest cost is less sensitive to market uncertainty than the cost of treasury bonds, since bonds with high coupon rates have low price risk when the interest rate fluctuates.

INNOVATIONS: NEW MARKET INSTRUMENTS

Any measure of the volume of financial innovation would register an explosion in the last ten years. For example, the swap market has grown from zero to hundreds of billions of dollars in this period. The number of traded financial futures contracts has increased from a handful to nearly one hundred. The explosion is one of both scale and variety. Even the British Government now issues gilts with non-standard coupon rates and conversion features apparently tailored to a whole range of specialised clienteles.

The Empirical Implications of the Cox, Ingersoll, Ross Theory of the Term Structure of Interest Rates

ABSTRACTThe one‐factor version of the Cox, Ingersoll, and Ross model of the term structure is estimated using monthly quotes on U.S. Treasury issues trading from 1952 through 1983. Using data from a single yield curve, it is possible to estimate implied short and long term zero coupon rates and the implied variance of changes in short rates. Analysis of residuals points to a probable neglected tax effect.

Dollar Eurobond and U.S. Bond Pricing

This study develops equilibrium yield relationships between otherwise similar dollar denominated Eurobonds and U.S. bonds with the use of supply and demand conditions and the standard arbitrage argument. It them empirically tests the hypothesis that no yield differentials exist between similar securities in these two markets. A matched pair sample of these bonds is obtained on the basis of five criteria: (a) same parent; (b) same rating; (c) similar coupon rates; (d) similar time to maturity; and (e) yield observations from the same month. Empirical results obtained during 1975 to 1983 shows that dollar Eurobond yields do not differ from domestic bond yields for comparable securities. This implies that these two markets are either devoid of systematic and material imperfections, or if any such imperfection do exist, their pricing influence is similar in both markets. It is also observed that issue size, issuer's rating and the market's familiarity with the issuer do not uniquely influence Eurobond pricing any differently than domestic U.S. bond pricing.