Uncover Everything You Need to Know About Debt Capital Markets

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Fixed-income markets in which sovereign and semi-governments, supranational organizations like the World Bank, corporations, and financial institutions issue debt in bonds and loans are called debt capital markets. Borrowers use these products to generate funds for expansion, mergers, development, or to broaden their revenue sources.

Through taking these loans, governments and other organizations have a chance to maintain their growth, despite all the problems they might come across along the way. It is a system developed to help less-developed countries to reach their full potential. As we’ve said, there are numerous areas where these funds are invested. A good example of this investment is infrastructure.

Bonds and loans are two types of debt capital market products that differ in risk profile, maturity, and terms. Bonds are financial products sold to a wide range of investors in the secondary market. Bond markets are categorized into high-yield or junk bonds, investment-grade bonds, emerging market bonds, and securitized products. As you can see, there are numerous ways these can be issued. Naturally, the type you will decide on depends on the actual needs and preferences at hand.

Debt capital market divisions of investment banks collaborate with customers such as financial companies, corporations, and governments to provide fixed-income securities. They take care of the creation, structure, operation, and distribution of a wide range of debt-related products. Therefore, it is important to have a proper understanding of these. Today, we want to share the most important pieces of information that can help with understanding the picture properly.

Bond Markets and Issuer Types

The bond market provides a diverse range of maturities, from short-term bonds to intermediate and long-term securities. Short-term bonds have a maturity of fewer than five years. Intermediate-term bonds have maturities of up to ten years, and long-term bonds have maturities ranging from ten to thirty years. So, you can see that the time length preferred by someone will play a vital role in deciding which one of these will be conducted.

An investment bank can underwrite the bond issues, which means they buy and sell newly issued bonds from the issuer. When an issue is very big for a single bank, syndication of bonds takes and other institutions take part in the underwriting. Government bonds, such as treasury bills, municipal bonds, and sovereign bonds, are part of the bond market. The others are emerging market bonds, corporate bonds, leveraged loans, and asset-backed securities.

  • Government bonds

Source: learnbonds.com

Governments of countries across the world sell bonds to fund their spending and budgetary deficits. They are risk-free, but the conditions and coupon rate are determined by how the market perceives the issuing country’s credibility. These bonds are fully supported by the government and carry less risk.

On the other hand, corporate bonds include investment-grade bonds, commercial paper, high-yield bonds or junk bonds, and leveraged loans. Large corporations typically issue these bonds to fund expansion, capital expenditures, or M&A activities. They may also issue new loans with better conditions to pay off previous debt.

  • Investment-grade bonds

These bonds are issued by the most creditworthy companies and receive the highest ratings.

  • High-yield bonds

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Often known as junk bonds, they are known to have a larger default risk than investment-grade bonds and hence pay higher coupon rates. These bonds are typically issued by corporations that may struggle to meet their financial obligations in full and on schedule. Junk bonds often have shorter maturities, with durations of 10 years or shorter.

  • Leveraged loans

These loans are given to businesses that have a bad credit history or a lot of debt. They are often syndicated and used to finance highly leveraged or speculative businesses. Because increased leverage implies a greater chance of failure and bankruptcy, these loans have higher interest rates and more stringent covenants.

  • Emerging market bonds

Source: citywire.com

They are issued by developing countries, typically by their governments. However, they can also be issued by companies. Because their credit ratings are lower than those of developed market bonds, their yields are greater. While there are advantages to investing in emerging market fixed income, there are also concerns such as economic disruption, political instability, inflation, less developed regulatory and legal frameworks, and the lack of capacity to repatriate returns.

They are also more susceptible to geopolitical developments and bear interest rates, liquidity, and exchange rate risk. Investors may suffer due to a lack of transparency from issuers and in financial markets, and assets may be appropriated. It is commonly known as country risk. Default risk has increased, resulting in greater interest payments on emerging market debt.

  • Municipal bonds

These are bonds issued by municipalities, states, and counties to fund big capital expenses such as infrastructure investments. These bonds are normally of investment-grade quality; however, they are less liquid than treasury bills.

Shifting Balance of the Power

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One of the easiest things to understand when it comes to these is that when the market volatility starts to stir, and as a result, the rates go up, then it becomes obvious that the balance of power shifts from the borrower to an investor. It needs to be said that 2020 and 2021 were the best example of how it looks like when the borrowers have all the standards up to their liking.

It manifested itself through borrowers’ ability to sell their assets whenever they want and they were able to dictate the spread. However, we can see that things have started to change in the last couple of months. Today, investors have an opportunity to pick their decisions and power to control every part of the procedure. Naturally, that doesn’t mean that borrowers cannot have at least some kind of control, but it is pretty limited when you compare it to some periods.

Since this is the case, they need to be extremely picky about the strategies they will utilize. All the elements have become significantly more complicated than they have been just a couple of months ago.

Debt Securities

Another important aspect to have an insight into is debt securities. We are talking about assurances that a certain entity, either a country or a company will repay all its debts within a certain period and that these transactions will be conducted in the safest possible way. In cases when the borrower is not able to pay these, interest rates will skyrocket.

On the other side, when a borrower is completely able to repay these debts then we can see that the rates will start to drop. There are two main elements of making sure that debt securities are on a satisfactory level. The first one is obtaining these at the primary market, and the second is choosing a secondary market.

The first one is where governments or companies will issue their bonds. The second one is where individuals have received their bonds and they can resell them either for a lower or higher price. As you know, the price is determined by having an insight into supply and demand.

In Conclusion

To conclude, financial institutions like DBS provide businesses access to funds through their extensive product portfolio of Asia’s top equity capital and debt capital market houses. They can create, execute, and distribute equity and debt instruments via private and public offerings. Customers can gain from their strong capital markets presence, track record, differentiated market knowledge, and worldwide investor connectivity.