Abstract
New financial instruments emerge, are tested, appear dead, only to reappear in a more sustainable form. Both commercial paper and high yield bonds are examples as finance evolves with the economy.
The worst loans are made in the best of times. There is a procyclical pattern to both the supply and demand for bonds but when an economic shock happens, the viability of corporate debt and financial innovations is tested.
When examining the evidence of corporate balance sheets, there are distinct cyclical and structural patterns in financial benchmarks such as the corporate short-term to long-term debt ratio and the ratio of corporate debt to equity.
The distinction between ex ante and ex post returns brings in the all-important role of expectations and cognitive biases. This emphasizes the linkage between interest rates, exchange rates, and sovereign risk in the U.S. context.
This is a preview of subscription content, log in via an institution to check access.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
A high yield bond today is a non-investment grade bond which has a higher risk of default due to adverse credit events (poor earnings over the economic cycle for example) and offer higher interest rate returns than investment grade bonds as compensation for risk.
- 2.
The leveraged buyout is the case where the acquiring firm issues below investment grade debt to help pay for an acquisition and then use the target’s cash flow to help pay the debt over time.
- 3.
Commercial paper rates rose from 8.28% in 1872 to 10.27% in 1873. They fell to 5.98% in the first complete year, 1874, of the Depression of 1873–1879, “A History of Interest Rates,” Sidney Homer, Rutgers State University, 1963. p. 319.
- 4.
Sidney Homer, A History of Interest Rates, Rutgers University Press, 1963, pp. 314–316. As a benchmark for the financial markets, the Dow Jones Transportation Index was created in 1884, before the Dow Jones Industrial Index. The transportation index had 9 railroads, including the Chicago & North Western, Union Pacific and the New York Central as some of the 11 components.
- 5.
High yield spreads rose quickly after the 1987 stock market crash from 12.59 in September to 14.31 in November 1987 and then again in 1990 on the onset of the recession, from 15.04% in August to 18.78 percent in November. Salomon Brothers mimeo.
- 6.
Life Insurance companies are one example specifically cited as matching duration in “Long-Duration Bond Funds Thrive Amid Market Carnage” March 16, 2020 Wall Street Journal.
- 7.
For an example of this, see the initial approach to COVID shutdowns and their impact on investor expectations in “Asset Managers rocked by Record Bond Fund Outflows”, March 20, 2020, Financial Times.
- 8.
“Investors spooked by outbreak seek safety [price protection] in money market funds,” March 27, 2020 Financial Times.
- 9.
“Bond ETFs Climb as the Fed Kicks Off Historic Purchase Program,” May/13, 2020 Wall Street Journal.
- 10.
As in an earlier chapter, the issues of adverse selection and asymmetric information will also apply here. The experience of WeWork and the skepticism of its business model is reflected in “As WeWork Grew, Wall Street Lent It Money and Credibility,” November 8, 2019 Wall Street Journal.
- 11.
Comments on Credit, various issues, Salomon Brothers.
- 12.
“U.S. companies near 2019 bond-issuance total with coronavirus binge,” June 16, 2020 Financial Times.
- 13.
David Romer, “Advanced Macroeconomics,” pp. 387–388, McGraw Hill Irwin, their edition, 2006.
- 14.
Mark Gertler and Simon Gilchrist note that due to imperfect capital markets, small firms are likely to face larger barriers to outside finance than small firms. See “Monetary Policy, Business Cycles, and the Behavior of Small Manufacturing Firms, “Quarterly Journal of Economics 109 (May 1994): 309–340.
- 15.
“Twitter Sells Bonds at Low Rate”, December 06, 2019. Wall Street Journal.
- 16.
An interesting paper that predates the 2020 intervention and offers some insight on the Fed, liquidity and corporate finance is found in Guillaume Rocheteau, Randall Wright, and Cathy Zhang, “Corporate Finance and Monetary policy,” American Economic Review, 2018, 108 (4–5): 1147–1186.
- 17.
“Are We in Recession? Yes, Says John Silvia; Maybe, Says Ed Hyman,” September 3, 1990 Barron’s.
- 18.
“Investors fret as leveraged loan market gets junkier,” June 8, 2020 Financial Times.
- 19.
Phelan examines the leverage and risk in the banking sector and emphasizes the dynamic nature of leverage and intermediation there. Gregory Phelan “Financial Intermediation, Leverage and Macroeconomic Instability,” American Economic Journal, 2016, 8(4): 199–224.
- 20.
The interest coverage ratio was cited in my Barron’s interview, September 3, 1990 as a signal of a possible forthcoming recession—which in fact did occur. “Are We in Recession? Yes, says John Silvia, Maybe says Ed Hyman,” Barron’s September 3, 1990.
- 21.
“Investors Rush into Havens as Growth Fears Persist,” August 9, 2019 Wall Street Journal.
- 22.
Consider the following headline for perspective “US corporate debt is high but not yet dangerous,” Financial Times April 11, 2019.
- 23.
United Artists, 2002.
- 24.
“Leveraged loans: the unbearable liteness of covenants,” Oct. 21, 2020, Financial Times.
- 25.
“IMF downgrades are a warning to the world,” Financial Times June 25, 2020.
- 26.
The ratio itself has been a subject of study and the proposition that the value of the firm is independent of the debt/equity ratio is well known. For a note on this see Merton H. Miller, “The Modigliani–Miller Propositions After Thirty Years,” Journal of Economic Perspectives V. 2 No. 4 Fall 1988 pp. 99–120.
- 27.
The substitution of debt for equity in many deals, independent of the outlook for the economy or interest rates, has led to financial stress in the corporate bond market. “More Companies Stumble Under Debt Load.” Barron’s March 18, 2018.
- 28.
One look at credit spreads and business cycles is Hui Chen “Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure,” Journal of Finance, Vol. LXV, No. 6, December 2010.
- 29.
“Money pours into US corporate debt despite warnings,” Financial Times November 21, 2019.
- 30.
30Real Capital Analytics, CoStar and Wells Fargo Economics, October 2019.
- 31.
Even within an economic expansion, changes in the fortunes of different sectors can bring forth financial stress. See “Wave of Financial Stress Hits Low-Rated Companies,” Wall Street Journal October 22, 2019.
- 32.
Analytical Record of Yields and Yield Spreads, March 1990, Salomon Brothers.
- 33.
Ned Davis Quarterly Data release June 2003.
- 34.
Corporate incentives to borrowing is reviewed in Stewart C. Myers, Determinants of Corporate Borrowing,” Journal of Financial Economics, 1977. V. 5 pp. 147–175.
- 35.
“Argentina’s ‘Preposterous’ Century Bond Never Got Chance to Grow Old,” Wall Street Journal September. 1, 2020.
- 36.
Niall Ferguson, “The Ascent of Money,” The Penguin Press, 2008. Pp. 92–97.
- 37.
Marc Weidenmier, “Money and Finance in the Confederate States of America”, EH.Net Encyclopedia.
- 38.
“Oil industry faces biggest crisis in 100 years”, Financial Times March 26, 2020,
- 39.
“US shale industry braces for wave of bankruptcies”, Financial Times May 26, 2020.
References
Barron’s, “Are We in Recession? Yes, Says John Silvia; Maybe, Says Ed Hyman,” September 3, 1990 Barron’s.
Richard A. Brealey and Stewart C. Myers, “Principles of Corporate Finance,” Third Edition, 1988, McGraw-Hill, Inc. New York. My basic text on corporate finance.
Hui Chen “Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure,” Journal of Finance, Vol. LXV, No. 6, December 2010. This note is one look at credit spreads and business cycles.
Niall Ferguson, “The Ascent of Money,” The Penguin Press, 2008. Pp. 92–97. An interesting note on the shift in Confederate finance during the U.S. Civil War.
Sidney Homer, A History of Interest Rates, Rutgers University Press, 1963.
Mark Gertler and Simon Gilchrist note that due to imperfect capital markets, small firms are likely to face larger barriers to outside finance than small firms. See “Monetary Policy, Business Cycles, and the Behavior of Small Manufacturing Firms, “Quarterly Journal of Economics 109 (May 1994): 309–340.
Merton H. Miller, “The Modigliani-Miller Propositions After Thirty Years,” Journal of Economic Perspectives V. 2 No. 4 Fall 1988 pp. 99–120. The debt/equity ratio itself has been a subject of study and the proposition that the value of the firm is independent of the debt/equity ratio is well known.
Stewart C. Myers, Determinants of Corporate Borrowing,” Journal of Financial Economics, 1977. V. 5 pp. 147–175. A review of corporate incentives to borrow.
Guillaume Rocheteau, Randall Wright, and Cathy Zhang, “Corporate Finance and Monetary policy,” American Economic Review, 2018, 108 (4–5): 1147–1186. An interesting paper that predates the 2020 intervention and offers some insight on the Fed, liquidity, and corporate finance.
David Romer, “Advanced Macroeconomics,” pp. 387–388, McGraw Hill Irwin, third edition, 2006. A fundamental review, and reminder of the user cost of capital.
Analytical Record of Yields and Yield Spreads, March 1990, Salomon Brothers.
Marc Weidenmier, “Money and Finance in the Confederate States of America”, EH.Net Encyclopedia. A view of financial flexibility during turbulent times.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
Copyright information
© 2021 The Author(s), under exclusive license to Springer Nature Switzerland AG
About this chapter
Cite this chapter
Silvia, J.E. (2021). Capital Markets: Financing Business Over the Long Term. In: Financial Markets and Economic Performance. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-76295-7_6
Download citation
DOI: https://doi.org/10.1007/978-3-030-76295-7_6
Published:
Publisher Name: Palgrave Macmillan, Cham
Print ISBN: 978-3-030-76294-0
Online ISBN: 978-3-030-76295-7
eBook Packages: Economics and FinanceEconomics and Finance (R0)