Debt Administration Lecture 13 November 29, 2005 PA 546  Constantine Hadjilambrinos
Federal Debt <ul><li>Primarily used to finance government operations. </li></ul><ul><li>Primarily short term. </li></ul><u...
State and Local Government (Municipal) Debt <ul><li>Primarily used to finance capital projects (infrastructure). </li></ul...
Appropriate Debt Policy <ul><li>Debt is usually the most appropriate financing option for capital projects. </li></ul><ul>...
Mechanics of Bond Values <ul><li>Calculation based on equations for present and future values. </li></ul><ul><li>FV n Futu...
Mechanics of Bond Values <ul><li>Special terminology for bonds. </li></ul><ul><li>P Price (present value) </li></ul><ul><l...
Debt Structure and Design <ul><li>Pursue  least-cost  marketability. </li></ul><ul><li>Simplify  debt management. </li></u...
Credit Ratings <ul><li>Three major credit rating firms: </li></ul><ul><ul><li>Moody’s (Aaa, Aa, A, Baa) </li></ul></ul><ul...
Credit Enhancements <ul><li>State-credit guarantees. </li></ul><ul><li>Promise by the state to make up any shortfall in lo...
Bond Issue Costs <ul><li>Underwriting fees (Underwriter purchases bond issue and resells it). </li></ul><ul><li>Rate insur...
Creative Finance  <ul><li>Lease-purchase financing. </li></ul><ul><li>Payments part of current operations expenditures. </...
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Lecture 13

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Lecture 13

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