Academic journal article Federal Reserve Bulletin

Anatomy of the Medium-Term Note Market

Academic journal article Federal Reserve Bulletin

Anatomy of the Medium-Term Note Market

Article excerpt

Over the past decade, medium-term notes (MTNs) have emerged as a major source of funding for U.S. and foreign corporations, federal agencies, supranational institutions, and sovereign countries. U.S. corporations have issued MTNs since the early 1970s. At that time, the market was established as an alternative to short-term financing in the commercial paper market and long-term borrowing in the bond market; thus the name "medium term." Through the 1970s, however, only a few corporations issued MTNs, and by 1981 outstandings amounted to only about $800 million. In the 1980s, the U.S. MTN market evolved from a relatively obscure niche market dominated by the auto finance companies into a major source of debt financing for several hundred large corporations. In the 1990s, the U.S. market has continued to attract a diversity of new borrowers, and outside the United States, the Euro-MTN market has grown at a phenomenal rate. By year-end 1992, outstanding MTNs in domestic and international markets stood at an estimated $283 billion (table 1).

1. Size of the worldwide medium-term note market,
year-end 1992

  Billions of dollars

Market sector                       outstanding,
                                   year-end 1992

Total                                   283

  U.S. market                           223
    Public MTNs f U.S. corporations     176
    Federal agency and others            16
    Private placements                   31

  International markets                  60
    Euro-MTNs                            50
    Foreign domestic markets             10

  Sources. Merrill Lynch & Co., Websters Communications International,
Federal Reserve Board.

Most MTNs are noncallable, unsecured, senior debt securities with fixed coupon rates and investment-grade credit ratings. In these features, MTNs are similar to investment-grade corporate bonds. However, they have generally differed from bonds in their primary distribution process. MTNs have traditionally been sold on a best-efforts basis by investment banks and other broker-dealers acting as agents. In contrast to an underwriter in the conventional bond market, an agent in the MTN market has no obligation to underwrite MTNs for the issuer, and the issuer is not guaranteed funds. Also, unlike corporate bonds, which are typically sold in large, discrete offerings, MTNs are usually sold in relatively small amounts either on a continuous or on an intermittent basis.

Borrowers with MTN programs have great flexibility in the types of securities they may issue. As the market for MTNs has evolved, issuers have taken advantage of this flexibility by issuing MTNs with less conventional features. Many MTNs are now issued with floating interest rates or with rates that are computed according to unusual formulas tied to equity or commodity prices. Also, many include calls, puts, and other options. Furthermore, maturities are not necessarily "medium term" - they have ranged from nine months to thirty years and longer. Moreover, like corporate bonds, MTNs are now often sold on an underwritten basis, and offering amounts are occasionally as large as those of bonds. Indeed, rather than denoting a narrow security with an intermediate maturity, an MTN is more accurately defined as a highly flexible debt instrument that can easily be designed to respond to market opportunities and investor preferences.

The emergence of the MTN market has transformed the way that corporations raise capital and that institutions invest. in recent years, this transformation has accelerated because of the development of derivatives markets, such as swaps, options, and futures, that allow investors and borrowers to transfer risk to others in the financial system who have different risk preferences. A growing number of transactions in the MTN market now involve simultaneous transactions in a derivatives market. …

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