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Wednesday 19 September 2018
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Primary Market Bond Issuance

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Just like equities can be issued through a primary issuance, secondary issuance or a treasury stock offering, corporate and government debt can be issued into public capital markets in the same way. Publicly traded debt is often divided into two types of bond: the corporate bond and the government bond. As their names indicate, the corporate bond is one that is issued by corporates, both large and small in size while the government bond is issued by municipal, provincial and federal governments. Bonds are typically priced according to the level of underlying risk that the entity issuing is assumed to have. Because governments are generally well-capitalized and deemed to be “safe” from a risk of default, the pricing for government bonds tends to be lower than most corporate bonds. Of course there are exceptions to this such as Greek and Argentinian debt at the height of their respective crises, but ceteris paribus, government bonds offer lower yield than their corporate counterparts. Besides the issuing entity difference, there is also a difference in the amount of yield and that is another factor that bonds can be segregated by. Typically, there are two types of bonds: investment grade bonds and high yield bonds. Investment grade bonds are those rated BBB and above by S&P (Baa for Moody’s) while high yield bonds (also called junk bonds) are those rates below that BBB threshold. These bonds typically offer higher yields to attract investors to take on the additional risk embedded in them. Just like any other risk-reward relationship, investors have to use their judgement with these bonds as to whether they have enough cash flow and capital to make regular debt service.

For the sake of this article, there will be a focus on municipal bond issuance. Like other debt securities, municipal bonds can be either publicly traded or given to other investing firms via a private placement. When underwriting the debt, the bankers set the price and yield of the bond and then purchase the bonds off the company issuing the debt through two main methods: a competitive sale and a negotiated sale. In a competitive sale, the underwriters are invited to submit sealed bids to the issuing company. The company with the lowest quoted rate of interest is awarded the deal. In a negotiated sale, the underwriter will already be chosen by the issuing company who would then manage all financing aspects. The issuer’s process of selection would include writing proposals, responding to the proposals, interviewing underwriters and then selecting the lead managers and co-managers. Once the selection process is complete, the managers would then buy the bonds and sell them to investors.

Because of the inherent risk of underwriting debt, banks often opt for a syndicated process i.e. an arrangement where multiple banks buy the debt together from the company (in varying amounts) to spread the risk of the investment. In the negotiated sale, the manager selected will contact other banks and invite them to be part of a syndicate through a form letter which is signed and returned. The participating members then come together to discuss a price to pay. On the other hand, in a competitive sale, the manager is authorized to serve as the group’s agent. Once the stock begins trading publicly, it becomes part of the secondary market where the company does not get the proceeds anymore. The debt is now owned by individual investors who participate in all the upside from that moment on. Once again, just like the primary issuance of equity, the company “cashes out” at the time of issuance. Following the initial issuance, the debt is listed on either the auction market or the negotiated market. In an auction market, the buyers and sellers compete amongst one another while in a negotiated market like the NASDAQ, the price is arrived upon by the buyer and the seller.