Title: Debt Administration
1Debt Administration
PA 546 Constantine Hadjilambrinos
- Lecture 13
- November 29, 2005
2Federal Debt
PA 546 Constantine Hadjilambrinos
- Primarily used to finance government operations.
- Primarily short term.
- Some debt is held by federal accounts and the
Federal Reserve System (Social Security,
Medicare/Medicaid). - Majority of debt held by private investors (60
in 2001). - Of this, a continually increasing amount (42.1
in 2001) is held by foreign investors. - This has serious implications for resource
allocation.
3State and Local Government (Municipal) Debt
PA 546 Constantine Hadjilambrinos
- Primarily used to finance capital projects
(infrastructure). - Primarily long term.
- Full faith and credit debtused for projects
that do not generate revenue. Often limited
statutorily. - Non-guaranteed debtRevenue bonds.
- Private debt Industrial Development Bonds.
4Appropriate Debt Policy
PA 546 Constantine Hadjilambrinos
- Debt is usually the most appropriate financing
option for capital projects. - If capital projects were to be financed from
current budget, most would be impossible. - Debt financing fulfills equity criteria users
pay for projects. - Most appropriate length of financing is to
coincide with useful life of project.
5Mechanics of Bond Values
PA 546 Constantine Hadjilambrinos
- Calculation based on equations for present and
future values. - FVn Future value in year n
- PV Present value
- r Rate of return/interest
- n Number of years
6Mechanics of Bond Values
PA 546 Constantine Hadjilambrinos
- Special terminology for bonds.
- P Price (present value)
- F Face value (future value)
- c Coupon rate (bond interest rate)
- r Market rate of return
- m Coupon period (annual or semi- annual)
Annual
Semi-annual
7Debt Structure and Design
PA 546 Constantine Hadjilambrinos
- Pursue least-cost marketability.
- Simplify debt management.
- Provide appropriate cost signals to decision
makers.
8Credit Ratings
PA 546 Constantine Hadjilambrinos
- Three major credit rating firms
- Moodys (Aaa, Aa, A, Baa)
- Standard and Poors (AAA, AA, A, BBB)
- Fitch (AAA, AA, A, BBB)
- Ratings reflect level of risk.
- Lower ratings mean higher interest rates must be
paid by bond issuers. - Investment grade Adequate safeguards against
default. - Junk bonds Lower than Baa or BBB rating (4-6
above U.S Treasury).
9Credit Enhancements
PA 546 Constantine Hadjilambrinos
- State-credit guarantees.
- Promise by the state to make up any shortfall in
local resources. - Bank letters of credit.
- Promise by a bank to make principal and interest
payments of specified amount and duration (there
is a fee). - Municipal bond insurance.
- Purchased from an insurer, takes payments on in
case of trouble (there is a fee).
10Bond Issue Costs
PA 546 Constantine Hadjilambrinos
- Underwriting fees (Underwriter purchases bond
issue and resells it). - Rate insurance (Provides security against rate
increases). - Pricing (Depends on Rating and maturity)can be
complicated for composite bond issue (comprising
of bonds of different maturities).
11Creative Finance
PA 546 Constantine Hadjilambrinos
- Lease-purchase financing.
- Payments part of current operations expenditures.
- Gets around various restrictions on government
borrowing.