Raising Capital - Creating Risk

Abstract

This paper discusses financial transactions through which a cash-driven market participant raises financing, such as, for instance, a manufacturer taking out a loan from a bank, a blue-chip company issuing bonds to the public, or a bank entering a repo with another bank. From the opposite perspective, that of the return-driven provider of financing, this type of transaction is an opportunity to earn a return, typically called interest, dividend or ‘the coupon’, respectively. Benjamin names this type of transaction ‘funded positions’, as they are characterised by the fact that the risk taker provides funds upfront and thereby incurs the immediate risks of losing them upon the insolvency of its counterparty.

The paper introduces functionally similar positions, such as syndicated loans, bonds and shares. It highlights the various parameters for which parties set values when entering such type of transaction. Further, the various ways of building risk mitigation devices into a financing transaction are discussed.

In its second part, the paper distinguishes the primary from the secondary market and presents the various options to get rid of an exposure, by either transferring or novating it, or by emulating it.

Keywords: loan, syndicated loan, bond, share, deposit, transfer, novation, participation

JEL Classification: K11; K12; K2