BORROWING

Debt Administration

Debt Structure & Design

Appropriate Debt Policy

THE NATURE OF BORROWING

• A transaction involving two parties, the borrower and the lender

• Borrowers get purchasing power now in return for an obligation to repay later

• Lenders give up current purchasing power in return for the promise of repayment later

• Bonds are the standard form taken by long-term obligations to repay debt

Vanilla BONDS• Obligations to pay a face amount or par value

(principal) at a specified retirement or maturity date and to make contractual interest payments until the debt is retired

• The stated or nominal interest on a bond is its coupon rate, the percentage of par value that will be paid on a regular basis, usually biannually. For example, a 9% coupon rate means that the bond pays $90 per $1000 each year

• Issuers sell bonds• Bond holders buy them, either at issue or in secondary

markets

Yield

• Yields often differ from coupon rates substantially• The present value of the bond may differ from the

face value substantially • Markets set bond values and implicitly a bond’s

discount rate (reflecting the current time value of money)

• The current bond price equals the present value of the cash flow to which the bondholder is entitled

DEBT STRUCTURE AND DESIGN

CRITERIA• Least-cost

marketability• Ease of administration• Provision of

appropriate cost signals

• Appropriate risk characteristics

VARIABLES• Type of security

(denomination, backing)

• Maturity• Term or Serial• Options and derivative

issues

BidsDETERMINATION • Denomination• Yield Structure of Bond• The economy and

governance of the bond issuer

• Its debt history• Rating• Availability of Bond

Insurance

EVALUATION• Underwriters package

and sell government debt

• TIC -- use IRR function on spreadsheet to calculate

DEBT POLICYREASONS FOR DEBT• Revenue shortfalls

– Structural deficits

– Cyclical deficits

– Temporary liquidity problems due to the timing of cash flows

• Capital-project construction

• CONSIDERATIONS• Borrowing cost vs. tax

cost• Effect upon future

solvency -- you really want to be able to borrow when you need to, not just when you want to

• Timing