Miles Livingston

A Comparison of Bond Ratings from Moody's S&P and Fitch IBCA

Previous research has found that the bond market values the ratings of Moodys and Standard & Poors. This paper extends earlier research by comparing the ratings of Moodys, Standard and Poors, and Fitch IBCA. The authors examine a very large database with monthly observations of bonds and bond ratings over a five-year time period. The analysis focuses on comparing rating levels, rating changes, and the impact of ratings on bond yields. The results show that firms with publicly available Fitch IBCA ratings have higher ratings from Moodys and S&P than firms without Fitch IBCA ratings. The typical firm releasing a Fitch IBCA rating has a lower yield (controlling for Moodys and S&P rating), a more stable rating, and is more likely to receive an upgrade. For split-rated bonds (Moodys vs. S&P), Fitch IBCA serves as a tiebreaker. This evidence is consistent with the bond market valuing the ratings of all three raters—Moodys, Standard & Poors, and Fitch IBCA.

Investment Bank Reputation and the Underwriting of Nonconvertible Debt

We examine the impact of investment banker prestige on underwriter spreads, offering yields, and other expenses for 2,449 nonconvertible industrial debt issues offered during the period 1990 to 1997. We find that higher prestige underwriters charge significantly lower underwriting fees. Offering yields are also lower and offering prices are higher for prestigious underwriters, which indicates that investment banker reputation acts to certify the value of a debt issue to investors. Other issuance expenses paid by the issuer are also lower for debt underwritten by the more prestigious investment banking firms. Lastly, we show that repeat business with the same investment banking firm leads to lower underwriting fees but does not significantly affect “other expenses” paid by the issuer.

Determinants of the call option on corporate bonds

Abstract A number of hypotheses have been proposed as explanations of the call feature in corporate bonds. Using a large sample of callable and noncallable corporate bonds issued during the period 1977–1986, this paper simultaneously examines the empirical validity of five hypotheses that have been offered to explain the call option. The evidence provides no support for the hypotheses that the call option provides managerial flexibility or tax advantages. There is mixed support for agency cost explanations of the corporate call feature. The call feature is found to be highly correlated with the level of interest rates and the maturity of debt issues. That is, the call feature is found to be more likely during periods of higher interest rates and for longer maturity bonds.

The Impact of Rule 144A Debt Offerings Upon Bond Yields and Underwriter Fees

Securities issued under Rule 144A do not have to file a public registration statement with the Securities and Exchange Commission, but can be sold only to qualified financial institutions. This paper examines industrial and utility bonds issued under Rule 144A. Rule 144A issues are found to have higher yields than publicly issued bonds after adjusting for risk. Yield premiums are higher if the issuer does not file periodic financial statements with the SEC. The yield premiums of Rule 144A issues may be due to lower liquidity, information uncertainty, and weaker legal protection for investors. Bonds issued under Rule 144A may have registration rights, which require the issuer to exchange the bonds for public bonds within a stated period, or pay higher yields. While high-yield bonds usually have registration rights, we find that the majority of investment-grade bonds do not. Registration rights have a greater impact on yields for high-yield than for investment-grade bonds. Underwriter fees for Rule 144A issues are not significantly different from underwriter fees for publicly issued bonds.

The Delivery Option on Forward Contracts

Many futures contracts contain a delivery option, which allows the short position a choice to deliver one of several varieties of a commodity. Several authors have argued that delivery options can have considerable value. For a forward contract with a delivery option, this paper shows that a continuously adjusted hedge will drive the value of the delivery option towards zero, assuming perfect and frictionless markets.

The Impact of a Third Credit Rating on the Pricing of Bonds

This article updates a study that looks at the impact of a third rating from Fitch IBCA on bond prices; it examines the impact on prices of a rating from Duff & Phelps Credit Rating Co. The empirical evidence indicates that a third credit rating from either DCR or Fitch has value to the bond market. When there is a third rating, upgrades by Moodys and Standard & Poors are more likely and downgrades less likely. Third ratings also have an incremental impact upon bond yields.

Taxation and Bond Market Equilibrium in a World of Uncertain Future Interest Rates: Reply

Models of security markets invariably assume that market participants act intelligently since any other assumption generally leads to absurd results. Schaefers Comment makes the incorrect assumption that one market participant, namely the government, acts unintelligently by allowing investors to reap tax arbitrage profits. Consequently, the conclusions in the Comment are erroneous. As I will show below, a government can (and the U.S. Government does) prevent tax arbitrage and any resulting disequilibrium in the bond market through two simple tax rules. My earlier paper [1] primarily showed that bond price must be a linear function of coupon for any maturity under the assumption of constant tax brackets for all investors, and then suggested that a linear relationship will also hold with investors in different tax brackets. I will prove this last result below.

The Pricing of Premium Bonds

In a recent paper, the author [8] has derived the equilibrium bond pricing equation in a world of uncertain future interest rates assuming that capital gains and losses will be taxed at maturity at capital gains tax rates. In the case of premium bonds (i.e., bonds selling above par), the U.S. tax law allows bondholders to elect to amortize the premium on a straight line basis as a deduction from regular taxable income. For those paying positive tax rates, the amortization option will generally be advantageous compared to taking a capital loss at maturity.

The Pricing of Municipal Bonds

In recent years, increased interest has developed in municipal bonds. This interest seems to be related to higher levels of interest rates, higher marginal tax rates for individuals because of inflation, and large demand for capital funds by municipalities. In spite of this greater awareness of municipal bonds, the academic literature lacks a rigorous analysis comparing municipal bonds with other bonds. The purpose of this paper is to partially fill this gap. Since one major characteristic differentiating municipal bonds from other bonds is the (federal) tax-free status of the coupons on municipals, this paper will trace out the implications of this differential tax treatment by comparing municipal bonds with fully-taxed bonds.

Measuring Bond Price Volatility

In the literature dealing with bond price volatility, there have been two divergent approaches. On the one hand, theoretical papers have looked at bond price volatility in the instantaneous framework of the calculus. Using the derivative of bond price (P) with respect to yield to maturity (y), it has been shown that volatility is linearly related to this derivative (dP/dy). (See [10].)