16.3. HOW TO WEIGH YOUR BORROWING ALTERNATIVES 621
notes issued by banks are calledcertificates of deposit(CDs).
Although anCPissue can be a one-time affair, many issuers have anCP-program
contract with a syndicate. A bare-bonesCPprogram simply eliminates the bother
of getting a syndicate together each time commercial paper needs to be placed, but
many programs also offer some form of underwriting commitment (for issues up to
a given amount and within a given period). Such a commitment can stipulate the
following terms:
A fixed spreadAn arrangement under which a borrower can issueCPat a fixed
spread, e.g. 0.5 percent overLIBOR, is called aNote Issuing Facility (NIF). This pre-
set spread may become too high later on, notably if the borrower’s rating improves
or if the average spread in the market falls. In such cases, the borrower loses—
he pays too much, in view of the changed circumstances—and the placing agent
gains because he or she can place the paper above the initially anticipated price. In
contrast, if the preset spread becomes too low, the borrower unambiguously wins;
the cost is then born by the underwriter, who has to buy the issue at a price that
exceeds the fair market value.
Figure 16.3 refers to aRUFextended to Malaysia’s Kertih.
The difference between aNIFand aRUFis less important than what it may seem
at first. Even aNIFis an option on a spread, not a forward contract on a spread,
because the borrower is under no obligation to use the facility. That is, if spreads go
down in the market, the borrower can simply forget about theNIFand issue paper
through a new syndicate or under a new agreement. Under such circumstances, the
advantage of theRUFto the borrower is that it avoids the cost and complications
of setting up a new issuing program and, of course, that there is a cap on the risk
spread.
16.3 How to Weigh your Borrowing Alternatives
Companies can get tentative offers from more than one bank or group of banks, or
offers in many currencies. How to compare them?
One of this book’s fundamental tenets is that, in a perfect market, everything
is priced correctly, and nothing is gained nor lost by the mere switching from one
borrowing alternative to another.npv’s on all financial transactions would be zero,
in the sense that thePVof the future service flows is fully reflected in the price. Yet
this does not mean that a real-worldCEOcan always relax and pick a loan at random
from any first-coming bank. Let’s review a few arguments that came up already in
the preceding chapters, and add a few new ones. We group the relevant items under
two headings: interactions with operational cash flows, and market imperfections.
Interactions with operations To a company, a financial contract may deliver
more than the contract’s very own cash flows; notably, as we saw in Chapter