Anatomy of the medium-term note market.

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

                                      Amount
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.

This article discusses the history and economics of the MTN market, analyzes statistics on MTNs collected by the Federal Reserve, and reviews recent developments in the U.S. and Euro-MTN markets.(1)

BACKGROUND OF THE MTN MARKET(2)

General Motors Acceptance Corporation (GMAC) created the MTN market in the early 1970s as an extension of the commercial paper market. To improve their asset-liability management, GMAC and the other auto finance companies needed to issue debt with a maturity that matched that of their auto loans to dealers and consumers. However, underwriting costs made bond offerings with short maturities impractical, and maturities on commercial paper cannot exceed 270 days. The auto finance companies therefore began to sell MTNs directly to investors. In the 1970s, the growth of the market was hindered by illiquidity in the secondary market and by securities regulations requiring approval by the Securities and Exchange Commission (SEC) of any amendment to a registered public offering. The latter, in particular, increased the costs of issuance significantly because borrowers had to obtain the approval of the SEC each time they changed the posted coupon rates on their MTN offering schedule. To avoid this regulatory hurdle, some corporations sold MTNs in the private placement market.

In the early 1980s, two institutional changes set the stage for rapid growth of the MTN market. First, in 1981 major investment banks, acting as agents, committed resources to assist in primary issuance and to provide secondary market liquidity. By 1984, the captive finance companies of the three large automakers had at least two agents for their MTN programs. The ongoing financing requirements of these companies and the competition among agents established a basis for the market to develop. Because investment banks stood ready to buy back MTNs in the secondary market, investors became more receptive to adding MTNs to their portfolio holdings. In turn, the improved liquidity and consequent reduction in the cost of issuance attracted new borrowers to the market.

Second, the adoption by the SEC of Rule 415 in March 1982 served as another important institutional change. Rule 415 permits delayed or continuous issuance of so-called shelf registered corporate securities. Under shelf registrations, issuers register securities that may be sold for two years after the effective date of the registration without the requirement of another registration statement each time new offerings are made. Thus, shelf registration enables issuers to take advantage of brief periods of low interest rates by selling previously registered securities on a moment's notice. In contrast, debt offerings that are not made from shelf registrations are subject to a delay of at least forty-eight hours between the filing with the SEC and the subsequent offering to the public.

The ability of borrowers to sell a variety of debt instruments with a broad range of coupons and maturities under a single prospectus supplement is another advantage of a shelf-registered MTN program. Indeed, a wide array of financing options have been included in MTN filings.(3) For example, MTN programs commonly give the borrower the choice of issuing fixed- or floating-rate debt.(4) Furthermore, several "global" programs allow for placements in the U.S. market or in the Euro-market. Other innovations that reflect the specific funding needs of issuers include MTNs collateralized by mortgages issued by thrift institutions, equipment trust certificates issued by railways, amortizing notes issued by leasing companies, and subordinated notes issued by bank holding companies. Another significant innovation has been the development of asset-backed MTNs, a form of asset securitization used predominantly to finance trade receivables and corporate loans. This flexibility in types of instruments that may be sold as MTNs, coupled with the market timing benefits of shelf registration, enables issuers to respond readily to changing market opportunities.

In the early and mid-1980s, when finance companies dominated the market, most issues of MTNs were fixed rate, noncallable, and unsecured, with maturities of five years or less. In recent years, as new issuers with more diverse financing needs have established programs, the characteristics of new issues have become less generic. For example, maturities have lengthened as industrial and utility companies with longer financing needs have entered the market. Indeed, frequent placements of notes with thirty-year maturities have made the designation "medium term" something of a misnomer.

MECHANICS OF THE MARKET

The process of raising funds in the public MTN market usually begins when a corporation files a shelf registration with the SEC.(5) Once the SEC declares the registration statement effective, the borrower files a prospectus supplement that describes the MTN program. The amount of debt under the program generally ranges from $100 million to $1 billion. After establishing an MTN program, a borrower may enter the MTN market continuously or intermittently with large or relatively small offerings. Although underwritten corporate bonds may also be issued from shelf registrations, MTNs provide issuers with more flexibility than traditional underwritings in which the entire debt issue is made at one time, typically with a single coupon and a single maturity.

The registration filing usually includes a list of the investment banks with which the corporation has arranged to act as agents to distribute the notes to investors. Most MTN programs have two to four agents. Having multiple agents encourages competition among investment banks and thus lowers financing costs. The large New York-based investment banks dominate the distribution of MTNs.

Through its agents, an issuer of MTNs posts offering rates over a range of maturities: for example, nine months to one year, one year to eighteen months, eighteen months to two years, and annually thereafter (see table 2). Many issuers post rates as a yield spread over a Treasury security of comparable maturity. The relatively attractive yield spreads posted at the maturities of three, four, and five years shown in table 2 indicate that the issuer desires to raise funds at these maturities. The investment banks disseminate this offering rate information to their investor clients. When an investor expresses interest in an MTN offering, the agent contacts the issuer to obtain a confirmation of the terms of the transaction. Within a maturity range, the investor has the option of choosing the final maturity of the note sale, subject to agreement by the issuing company. The issuer will lower its posted rates once it raises the desired amount of funds at a given maturity. In the example in table 2, the issuer might lower its posted rate for MTNs with a five-year maturity to 40 basis points over comparable Treasury securities after it sells the desired amount of debt at this maturity. Of course, issuers also change their offering rate scales in response to changing market conditions. Issuers may withdraw from the market by suspending sales or, alternatively, by posting narrow offering spreads at all maturity ranges. The proceeds from primary trades in the MTN market typically range from $1 million to $25 million, but the size of transactions varies considerably.(6) After the amount of registered debt is sold, the issuer may "reload" its MTN program by filing a new registration with the SEC.

[TABULAR DATA OMITTED]

Although MTNs are generally offered on an agency basis, most programs permit other means of distribution. For example, MTN programs usually allow the agents to acquire notes for their own account and for resale at par or at prevailing market prices. MTNs may also be sold on an underwritten basis. In addition, many MTN programs permit the borrower to bypass financial intermediaries by selling debt directly to investors.

THE ECONOMICS OF MTNS AND

CORPORATE BONDS

In deciding whether to finance with MTNs or with bonds, a corporate borrower weighs the interest cost, flexibility, and other advantages of each security.(7) The growth of the MTN market indicates that MTNs offer advantages that bonds do not. However, most companies that raise funds in the MTN market have also continued to issue corporate bonds, suggesting that each form of debt has advantages under particular circumstances.

Offering Size, Liquidity, and Price

Discrimination

The amount of the offering is the most important determinant of the cost differential between the MTN and corporate bond markets. For large, standard financings (such as $300 million of straight debt with a ten-year maturity) the all-in interest cost to an issuer of underwritten corporate bonds may be lower than the all-in cost of issuing MTNs. This cost advantage arises from economies of scale in underwriting and, most important, from the greater liquidity of large issues. As a result, corporations that have large financing needs for a specific term usually choose to borrow with bonds. From an empirical point of view, the liquidity premium, if any, on small offerings has yet to be quantified. Nevertheless, the sheer volume of financing in the MTN market suggests that any liquidity premium that may exist for small offerings is not a significant deterrent to financing. According to market participants, the interest cost differential between the markets has narrowed in recent years as liquidity in the MTN market has improved. Many borrowers estimate that the premium is now only about 5 to 10 basis points.(8)

Furthermore, many borrowers believe that financing costs are slightly lower in the MTN market because its distribution process allows borrowers to price discriminate. Consider a stylized example of a company that needs to raise $100 million. With a bond offering, the company may have to raise the offering yield significantly, for example, from 6 percent to 6.25 percent, to place the final $10 million with the marginal buyer. In contrast, with MTNs the company could raise $90 million by posting a yield of 6 percent; to raise the additional $10 million, the company could increase its MTN offering rates or issue at a different maturity. Consequently, because all of the debt does not have to be priced to the marginal buyer, financing costs can be lower with MTNs.

The Flexibility of MTNs

Even if conventional bonds enjoy an interest cost advantage, this advantage may be offset by the flexibility that MTNs afford. Offerings of investment-grade straight bonds are clustered at standard maturities of two, three, five, seven, ten, and thirty years. Also, because the fixed costs of underwritings make small offerings impractical, corporate bond offerings rarely amount to less than $100 million. These institutional conventions impede corporations from implementing a financing policy of matching the maturities of assets with those of liabilities. By contrast, drawdowns from MTN programs over the course of a month typically amount to $30 million, and these drawdowns frequently have different maturities and special features that are tailored to meet the needs of the borrower. This flexibility of the MTN market allows companies to match more closely the maturities of assets and liabilities.

The flexibility of continuous offerings also plays a role in a corporation's decision to finance with MTNs. With MTNs, a corporation can "average out" its cost of funds by issuing continuously rather than coming to market on a single day. Therefore, even if bond offerings have lower average yields, a risk-averse borrower might still elect to raise funds in the MTN market with several offerings in a range of $5 million to $10 million over several weeks, rather than with a single $100 million bond offering.

The flexibility of the MTN market also allows borrowers to take advantage of funding opportunities. By having an MTN program, an issuer can raise a sizable amount of debt in a short time; often, the process takes less than half an hour. Bonds may also be sold from a shelf registration, but the completion of the transaction may be delayed by the arrangement of a syndicate, the negotiation of an underwriting agreement, and the

"pre-selling" of the issue to investors. Furthermore, some corporations require that underwritten offerings receive prior approval by the president of the company or the board of directors. In contrast, a corporate treasurer may finance with MTNs without delay and at his or her discretion.(9)

Discreet Funding with MTNs

The MTN market also provides corporations with the ability to raise funds discreetly because the issuer, the investor, and the agent are the only market participants that have to know about a primary transaction. In contrast, the investment community obtains information about underwritten bond offerings from a variety of sources.

Corporations often avoid the bond market in periods of heightened uncertainty about interest rates and the course of the economy, such as the period after the 1987 stock market crash. Underwritings at such times could send a signal of financial distress to the market. Similarly, corporations in distressed industries, such as commercial banking in the second half of 1990, can use the MTN market to raise funds quietly rather than risk negative publicity in the high profile bond market. Thus, during periods of financial turmoil, the discreet nature of the MTN market makes it an attractive alternative to the bond market.

"Reverse Inquiry" in the MTN market

Another advantage of MTNs is that investors often play an active role in the issuance process through the phenomenon known as "reverse inquiry." For example, suppose an investor desires to purchase $15 million of A-rated finance company debt with a maturity of six years and nine months. While such a security may not be available in the corporate bond market, the investor may be able to obtain it in the MTN market through reverse inquiry. In this process, the investor relays the inquiry to an issuer of MTNs through the issuer's agent. If the issuer finds the terms of the reverse inquiry sufficiently attractive, it may agree to the transaction even if it was not posting rates at the maturity that the investor desires.

According to market participants, trades that stem from reverse inquiries account for a significant share of MTN transactions. Reverse inquiry not only benefits the issuer by reducing borrowing costs but also allows investors to use the flexibility of MTNs to their advantage. In response to investor preferences, MTNs issued under reverse inquiry often include embedded options and frequently pay interest according to unusual formulas. This responsiveness of the MTN market to the needs of investors is one of the most important factors driving the growth and acceptance of the market.

THE FEDERAL RESERVE BOARD'S SURVEY

OF U.S. CORPORATE MTNS

The Federal Reserve surveys U.S. corporations with MTN programs. These companies provide data on a confidential basis on the amount of MTNs they issue; respondents report monthly, quarterly, or annually depending on how active they are in the market. At year-end, all MTN issuers are asked to provide data on the amount of their outstandings. The data on gross issuance begin in January 1983, and the data on outstandings have been collected since year-end 1989. The Federal Reserve obtains information on new programs from announcements of SEC Rule 415 registrations and contacts with MTN agents.

Because the participation rate in the Federal Reserve survey is 100 percent, it provides an accurate measure of the volume of MTN financing by U.S. corporations in the U.S. public market. However, while the U.S. corporate sector is the largest segment of the MTN market, MTNs have been issued in other markets and by non-U.S. corporations. For example, several U.S. corporations have issued MTNs in the Euro-market. Also, the survey does not include MTNs issued in the U.S. public market by government-sponsored agencies, such as the Federal National Mortgage Association, by supranational institutions, and by non-U.S. corporations. Furthermore, although the database includes MTNs issued by bank holding companies, it does not include deposit notes and bank notes offered by banks because these securities are exempt from SEC registration. Perhaps most important, the database does not include privately placed MTNs. The private placement market is particularly attractive to issuers who wish to gain access to U.S. investors without having to obtain SEC approval for a public offering. According to MTN agents, non-U.S. corporations are the largest borrowers in the market for privately placed MTNs. Because the financing costs are usually lower in the public market than in the less liquid private market, most U.S. corporations choose to issue public, SEC-registered MTNs.

Issuance Volume and Industry of the Issuers

From 1983 through 1992, the volume of MTN issuance in the public market increased in each year, rising from $5.5 billion in 1983 to $74.2 billion in 1992, and totaled $330 billion over the ten-year period (table 3). Similarly, the number of borrowers increased from 12 in 1983 to 208 in 1992, and totalled 402 corporations for the period (table 3).

[TABULAR DATA OMITTED]

Borrowers in the MTN market span a wide array of industry groups. In the financial sector, major borrowers include auto finance companies, bank holding companies, business and consumer credit institutions, and securities brokers. In the nonfinancial sector, participants in the MTN market include utilities, telephone companies, manufacturers, service firms, and wholesalers and retailers. Within industry groups, the auto finance companies have been the heaviest borrowers, raising $88 billion over the period. In relative terms, however, issuance by auto finance companies declined from an 87 percent share of the MTN market in 1983 to 18 percent in 1992.

In the early to mid-1980s, financial companies dominated the MTN market. Indeed, in 1983, only two nonfinancial companies issued MTNs, and they accounted for less than 1 percent of the issuance volume. In recent years, however, nonfinancial companies have increased their share of the market, and from 1990 through 1992, they accounted for about one-third of MTN issuance.

The increase in the volume of MTN issuance reflects a dramatic increase in the number of new borrowers in the market. In each year from 1984 through 1992, at least twenty companies issued MTNs for the first time, and most of the new entrants have been nonfinancial companies. In 1991, for example, sixty-six new borrowers entered the market, of which fifty-five were nonfinancial companies. As a result of this trend, in each year beginning in 1990, the total number of nonfinancial firms issuing MTNs has exceeded the total number of financial issuers.

The Volume of Corporate MTNs Outstanding

and the Components of Net Borrowing

Outstanding MTNs and issuer use of MTN programs have increased sharply since 1989. In the aggregate, outstanding MTNs increased from $76 billion in 1989 to $176 billion in 1992 (table 4). Over this period, outstandings of nonfinancial firms increased from $18.5 billion to $67.6 billion, while outstandings of financial corporations increased from $57.5 billion to $108.2 billion. For individual firms, outstandings of MTNs averaged $504 million in 1992, compared with $350 million in 1989.

4. Medium-term notes outstanding, 1989-92

     Millions of dollars

                                     Year-end

Market sector            1989      1990      1991     1992

Total outstanding       76,016   100,040   142,316   175,782

  Financial             57,505    69,146    89,823   108,180
  Nonfinancial          18,511    30,894    52,493    67,602

Average outstanding        350       383       453       504
  Financial                504       591       788       925
  Nonfinancial             180       215       262       291

The data on net borrowing, that is, the year-over-year change in outstandings, can be dissected to determine the sources of growth in the market. For the market as a whole, new entrants accounted for about one-third of net borrowing in 1990, one-fourth of net borrowing in 1991, and less than one-fifth in 1992 (table 5). Thus, firms that had already issued MTNs accounted for most of the recent growth in the market. In the financial sector, in particular, new entrants accounted for only a small proportion of the growth, simply because a large share of the financial firms that could enter the MTN market did so in the 1980s. Among nonfinancial firms, in contrast, new entrants have continued to fuel a significant share of the growth in the market.

5. Analysis of net borrowing in the corporate
medium-term note market, 1990-92

     Millions of dollars

                                         Year over year

Net borrowing,
by type of borrower                  1990     1991     1992

Total net borrowing
All U.S. corporations               24,024   42,275   33,466
  Financial                         11,641   20,677   18,357
  Nonfinancial                      12,382   21,599   15,109

Net borrowing by new entrants
All U.S. corporations                8,070    9,711    5,983
  Financial                          2,341    1,926      526
  Nonfinancial                       5,729    7,785    5,457

Net borrowing by existing issuers
All U.S. corporations               15,953   32,565   27,482
  Financial                          9,300   18,751   17,831
  Nonfinancial                       6,653   13,814    9,652

Memo: Ratio of net borrowing
by new entrants to total
net borrowing
All U.S. corporations                 .336     .230     .179
  Financial                           .201     .093     .029
  Nonfinancial                        .463     .360     .361

Credit Ratings

The corporations issuing MTNs have had high credit ratings. Since 1983, more dun 99 percent of MTNs have been rated investment grade (Baa or higher) at the time of issuance (table 6). In 1992, $51 billion of the $74 billion in MTN offerings were rated single A, and six firms, issuing a total of $540 million, had Ba ratings. Outstanding MTNs also tend to have high credit ratings, but not as high as the ratings on new offerings because of the preponderance of rating downgrades in recent years. Nevertheless, 98 percent of outstanding MTNs were rated investment grade at year-end 1992 (table 7).

[TABULAR DATA OMITTED]

Maturities and Yield Spreads

Maturities on MTNs reflect the financing needs of the borrowers. Financial firms tend to issue MTNs with maturities matched to the maturity of loans made to their customers. Consequently, in the financial sector, maturities are concentrated in a range of one to five years, and only a small proportion are longer than ten years (chart 1). Nonfinancial firms, in contrast, often use MTNs to finance long-lived assets, such as plant and equipment. As a result, maturities on MTNs issued by nonfinancial corporations cover a wider range, and in 1992, 25 percent to 30 percent were longer than ten years.

Yields on fixed-rate MTNs, commonly quoted as a yield spread over a Treasury security of comparable maturity, reflect the credit risk of the borrower. Other factors held constant, Baa-rated MTNs have higher yield spreads than A-rated MTNs, which in turn have higher yield spreads than Aa-rated MTNs (chart 2). Yield spreads also vary over time, particularly over the course of the business cycle. Spreads on A-rated MTNs increased from 60 basis points over Treasury securities in July 1990, a cyclical trough, to 140 basis points in January 1991.(10)

The Relative Size of the MTN market

The MTN market accounts for a significant share of borrowing by U.S. corporations. One measure of the size of the market is the ratio of outstanding MTNs to the amount of outstanding public debt (MTNs plus public corporate bonds). According to this definition of market share, MTNs accounted for 16 percent of public corporate debt in 1992, compared with 9 percent in 1989 (table 8). This ratio understates the size of the MTN market, however, because the market is still relatively new, and outstandings are growing rapidly.

[TABULAR DATA OMITTED]

An alternative measure of the size of the market is the volume of investment-grade MTN issuance as a percentage of total investment-grade debt issuance (MTNs plus underwritten straight bonds). By this definition, the share of investment-grade debt issued as MTNs rose from 18 percent in 1983 to a peak of 42 percent in 1990 (table 9). In 1992, the ratio fell to 37 percent, a decline that mainly reflects the heavy volume of refinancing in the corporate bond market, especially in the nonfinancial sector. This ratio of debt issuance may overestimate the size of the MTN market because MTNs typically have shorter maturities than corporate bonds.

[TABULAR DATA OMITTED]

MTNs represent an increasingly important source of credit to nonfinancial corporations, as companies have shifted funding from alternative credit markets. In general, nonfinancial corporations that borrow in the MTN market have access to other major credit markets: corporate bonds, commercial paper, bank loans, and privately placed bonds. From 1989 through 1992, net borrowing by nonfinancial corporations in the MTN market increased $49 billion, while borrowing in the other four markets increased an estimated $102 billion (table 10). Notably, corporate borrowing in the public bond market rose $100 billion, while borrowing at banks fell $35 billion. The shift to long-term financing (MTNs and bonds) over this period is a typical, cyclical phenomenon that occurs in periods of slow economic growth and falling long-term interest rates. However, some of the growth of the MTN market reflects a secular decline in the role of banks as financial intermediaries.

10. Funding by nonfinancial corporations in major
domestic credit markets, 1989-92

     Billions of dollars

                     Outstandings at year-end   Net change
                                                   from
     Market               1989         1992    1989 to 1992

Medium-term notes         18.5         67.6        49.1
Public bonds             607.5        707.9       100.3
Commercial paper         107.1        108.3         1.2
Bank loans               553.5        518.8       -34.7
Privately placed bonds   265.0        300.0        35.0

  Source. For all series except public bonds, Federal Reserve Board;
for public bonds, Moody's Investors Service.

RECENT DEVELOPMENTS

IN THE MTN MARKET

In recent years several changes have occurred in the MTN market as a result of innovations in other capital markets. Among the most important changes in the MTN market are the increasing use of "structured" MTNs, the increasing participation by banking organizations in the market, and the development of a system for book-entry clearing and settlement of MTN transactions. Also, foreign corporations have begun to use the MTN market more frequently since the adoption of SEC Rule 144A in April 1990.

Structured MTNs

In recent years, an increasing share of MTNs have been issued as part of structured transactions. In a structured MTN, a corporation issues an MTN and simultaneously enters into one or several swap agreements to transform the cash flows that it is obligated to make. The simplest type of structured MTN involves a "plain vanilla" interest rate swap. In such a financing, a corporation might issue a three-year, floating-rate MTN that pays LIBOR plus a premium semiannually. At the same time, the corporation negotiates a swap transaction in which it agrees to pay a fixed rate of interest semiannually for three years in exchange for receiving LIBOR from a swap counterparty. As a result of the swap, the borrower has synthetically created a fixed-rate note because the floating-rate payments are offsetting. (See the box for an outline of this transaction.)

At first glance, structured transactions seem needlessly complicated. A corporation could simply issue a fixed-rate MTN. However, as a result of the swap transaction, the corporation may be able to borrow at a lower rate than it would pay on a fixed-rate note. Indeed, most MTN issuers decline to participate in structured financings unless they reduce borrowing costs at least 10 or 15 basis points. Issuers demand this compensation because, compared with conventional financings, structured financings involve additional expenses, such as legal and accounting costs and the cost of evaluating and monitoring the credit risk of the swap counterparty. For complicated structured transactions, most issuers require greater compensation.

Many structured transactions originate with investors through a reverse inquiry. This process begins when an investor has a demand for a security with specific risk characteristics. The desired security may not be available in the secondary market, and regulatory restrictions or bylaws prohibit some investors from using swaps, options, or futures to create synthetic securities. Through a reverse inquiry, an investor will use MTN agents to communicate its desires to MTN issuers. If an issuer agrees to the inquiry, the investor will obtain a security that is custom-tailored to its needs. The specific features of these transactions vary in response to changes in market conditions and investor preferences. For example, in 1991 many investors desired securities with interest rates that varied inversely with short-term market interest rates. In response to investor inquiries, several corporations issued "inverse floating-rate" MTNs that paid an interest rate of, for example, 12 percent minus LIBOR. At the time of the transaction, the issuers of inverse floating-rate MTNs usually entered into swap transactions to eliminate their exposure to falling interest rates.

While structured transactions in the MTN market often originate with investors, investment banks also put together such transactions. Most investment banks have specialists in derivative products who design securities to take advantage of temporary market opportunities. When an investment bank identifies an opportunity, it will inform investors and propose that they purchase a specialized security. If an investor tentatively agrees to the transaction, the MTN agents in the investment bank will contact an MTN issuer with the proposed structured transaction.

Most investors require that issuers of structured MTNs have triple-A or double-A credit ratings. By dealing with highly rated issuers, the investor reduces the possibility that the value of the structured MTN will vary with the credit quality of the issuer. In limiting credit risk, the riskiness of the structured MTN mainly reflects the specific risk characteristics that the investor prefers.(11) Consequently, federal agencies and supranational institutions, which have triple-A ratings, issue a large share of structured MTNs. The credit quality profile of issuers of structured MTNs has changed slightly in recent years, however, as some investors have become more willing to purchase structured MTNs from single-A corporations. In structured transactions with lower-rated borrowers, the investor receives a higher promised yield as compensation for taking on greater credit risk.

Market participants estimate that structured MTNs accounted for 20 percent to 30 percent of MTN volume in the first half of 1993, compared with less than 5 percent in the late 1980s. The growth of structured MTNs highlights the important role of derivative products in linking various domestic and international capital markets. Frequently, the issuers of structured MTNs are located in a different country from that of the investors.

The increasing volume of structured transactions is testimony to the flexibility of MTNs. When establishing MTN programs, issuers build flexibility into the documentation that will allow for a broad range of structured transactions. Once the documentation is in place, an issuer is able to reduce borrowing costs by responding quickly to temporary opportunities in the derivatives market. The flexibility of MTNs is also evident in the wide variety of structured MTNs that pay interest or repay principal according to unusual formulas. Some of the common structures include the following: (1) floating-rate MTNs tied to the federal funds rate, LIBOR, commercial paper rates, or the prime rate, many of which have included caps or floors on rate movements; (2) step-up MTNs, the interest rate on which increases after a set period; (3) LIBOR differential notes, which pay interest tied to the spread between, say, deutsche mark LIBOR and French franc LIBOR; (4) dual currency MTNs, which pay interest in one currency and principal in another; (5) equity-linked MTNs, which pay interest according to a formula based on an equity index, such as the Standard & Poor's 500 or the Nikkei; and (6) commodity-linked MTNs, which have interest tied to a price index or to the price of specific commodities such as oil or gold. The terms and features of structured MTNs continue to evolve in response to changes in the preferences of investors and developments in financial markets.

Bank Notes

Banking organizations are major participants in the MTN market. Like other corporations, bank holding companies must file registration documents with the SEC when issuing public securities. Consequently, the Federal Reserve survey captures MTNs issued by bank holding companies. Over the ten-year survey period, thirty-five bank holding companies raised funds in the MTN market, and from 1989 to 1992, outstanding MTNs of bank holding companies increased from $8.3 billion to $17.9 billion. Although most of these MTNs have senior status in relation to other debt outstanding, a few bank holding companies have issued subordinated MTNs. Subordinated MTNs of bank holding companies typically have long maturities of about ten years. Under regulatory capital requirements, subordinated debt with a maturity of five years or longer qualifies as tier 2 capital.

In contrast to public offerings by bank holding companies, securities issued by banks are exempt from registration under section 3(a)2 of the Securities Act of 1933. In recent years, a growing number of banks have issued exempt securities, called bank notes, that have characteristics in common with certificates of deposit (CDs), MTNs, and short-term bonds.

Like CDs, most bank notes are senior, unsecured debt obligations issued by the bank. In the event of the insolvency of the issuing institution, bank notes are likely to rank equal with deposits, except in states where deposits have priority over other debt obligations. As with institutional CDs, nearly all bank notes are sold to institutional investors in minimum denominations of $250,000 to $1 million. Bank notes are not covered by FDIC insurance, nor are they subject to FDIC insurance assessments. CDs, in contrast, are insured for $100,000 per depositor. Furthermore, in the event of a bank failure, the FDIC could choose to protect the financial interests of some or all depositors or other creditors without treating bank notes in the same manner.

Like MTNs, bank notes may be offered continuously or intermittently in relatively small amounts that typically range from $5 million to $25 million. In addition, as with MTNs, most medium-term bank notes have maturities that range from one to five years.(12) However, ratings on senior bank notes are typically one notch higher than the ratings on senior MTNs, which are issued at the holding company level. Reflecting these differences in ratings and priority in the firms' capital structures, the yields on banks notes usually are significantly lower than the yields on MTNs of comparable maturity.

Some bank notes, which are similar to corporate bonds, are sold in large, underwritten, discrete offerings that range from $50 million to $1 billion. However, they differ from corporate bonds in that they are not registered with the SEC. From 1988 through 1992, banks issued $14.3 billion of underwritten, senior bank notes, including $7.8 billion in 1992. In the first half of 1993, they issued $6.3 billion.

Book-Entry Clearing and Settlement of MTNs

In the early and mid-1980s, high administrative costs deterred some issuers from establishing MTN programs. Among the most significant of the administrative costs were those arising from transferring physical securities to investors. These costs included printing, delivery, safekeeping, messengers, insurance, and recordkeeping. Moreover, issuers incurred significant costs in the disbursement of interest and principal payments to each individual noteholder. According to market estimates, the direct costs of transferring physical securities range from $5 to $30 per transaction. For small offerings, the costs of physical delivery can add significantly to the all-in cost of borrowing. As a result, many issuers refused to sell MTNs in denominations of less than $1 million.

Since 1988, the costs of clearing and settlement of MTNs have decreased substantially as a computer-based system of book-entry recordkeeping has supplanted physical certificates. When an MTN is issued under the book-entry system, an agent bank for the issuer uses a computer link with The Depository Trust Company (DTC) to enter the descriptive information and settlement details of the transaction. The sales agent receives a copy of the computer record from DTC, and the investor receives a trade confirmation from the sales agent and periodic ownership statements from the custodian bank, in lieu of physical certificates. Secondary market trades are likewise recorded with computer entries. Under the book-entry system, an issuer makes one wire transfer to DTC that covers all interest payments on each interest payment date. This payment process contrasts with the process for physical certificates in which issuers make separate payments to each investor. Similarly, under the book-entry system, when the MTN matures, the issuer makes only one funds transfer to DTC. The DTC book-entry process costs $4 for each issuance, and each participant in a transaction pays between $1.29 and $1.54 for subsequent deliveries in the primary and secondary markets. Besides reducing the direct cost of issuance, the book-entry system also lowers the likelihood of delayed delivery because of logistical problems and reduces the chances of failed trades arising from paperwork errors.

Book entry has become the preferred method of clearing and settlement in the MTN market. According to DTC, issuance of book-entry MTNs rose from $600 million in 1988 to $80 billion in 1992 (table 11). Moreover, outstanding MTNs under the book-entry system amounted to $160 billion at year-end 1992, a total that includes 16,495 individual securities.(13)

11. Issuance and outstandings of book entry
medium-term notes, 1988-1993:Ql

                                  End of period

           Issuance
            volume      Principal
Period   (billions of     amount       Number of    Number of
           dollars)     outstanding    issuers      issues
                        (billions of
                          dollars)

1988          0.6            0.6           5           136
1989         15.6           16.2         138         2,001
1990         37.3           51.4         225         6,670
1991         66.5          106.2         368        12,660
1992         80.2          159.8         451        16,495
1993: Q1     25.4          177.8         484        17,254

Source. The Depository Trust Company.

Borrowing by Foreign Entities in the MTN

Market and SEC Rule 144A(14)

In the 1980s, SEC disclosure requirements associated with public offerings discouraged foreign corporations from issuing MTNs in the U.S. public market. For foreign corporations, the most burdensome requirement is that financial statements conform to U.S. generally accepted accounting principles. Most foreign issuers would have to incur considerable legal and accounting expenses to meet this requirement, and many would have to disclose more information about their operations than is required in their home markets. The expense of registering securities and satisfying ongoing reporting requirements has also deterred foreign entities from borrowing in the U.S. market. Foreign issuers could avoid the costs of a public offering by selling MTNs in the U.S. private placement market. However, yields on most private placements included an illiquidity premium resulting from regulatory restrictions on trading.

The adoption of SEC Rule 144A in April 1990 effectively created an alternative market in which foreign corporations could gain access to U.S. investors without having to satisfy the disclosure requirements for public offerings. Rule 144A allows institutional investors to trade private placements among themselves with few restrictions. To protect less sophisticated investors, the SEC requires that 144A securities be sold only to "qualified institutional buyers," which own and invest in a minimum of $100 million in securities. This definition is broad enough to include most of the institutions that buy MTNs, such as banks and bank trust departments, insurance companies, pension funds, mutual funds, investment advisers, and state and local governments.(15) A foreign issuer of a 144A security must provide, upon demand by a security holder or potential purchaser, a brief description of the business and financial statements for the three most recent fiscal years, which can be in the accounting format used in the issuer's home country. Privately placed MTNs are an example of a security that may be eligible for resale under Rule 144A.

Since the adoption of Rule 144A, issuance of MTNs by foreign corporations in the U.S. private market has increased markedly. According to the Securities Data Corporation, issuance increased from $2.2 billion in 1990 to $10 billion in 1992. In general, MTNs issued by foreign corporations under Rule 144A have similar characteristics to those sold by U.S. corporations in the public market. Both typically are dollar denominated and investment grade, with standard covenants.

DEVELOPMENTS IN THE DISTRIBUTION

OF MTNS

In the early and mid-1980s, the major difference between MTNs and corporate bonds was in their primary method of distribution: Typically, agents placed MTNs in relatively small amounts continuously or intermittently, while underwriters placed large, discrete amounts of corporate bonds. This strict classification no longer applies, however. A growing number of MTN offerings have the characteristics of traditional corporate bonds, and regional dealers now sell a significant percentage of MTNs. Thus, as the MTN market has matured, it has become harder to define the securities and to describe their mode of distribution.

Principal Transactions

One important change in the distribution process is that a larger share of MTNs are now sold on a principal basis, rather than on an agented basis. In a principal transaction, the MTN dealer purchases an MTN for its own account and later resells it to investors. In a "riskless principal" transaction, when the dealer buys the MTN, it has already lined up an investor that has agreed to the terms of the resale. Riskless principal transactions often involve structured MTNs. In other principal transactions, dealers underwrite MTNs when they have not lined up investors but expect to do so easily and quickly.

Large, Discrete Offerings

Corporations now more often sell MTNs that are nearly indistinguishable from corporate bond offerings. These MTN offerings typically have large face amounts of $100 million or more, the typical size of corporate bond offerings. They are sold on an underwritten basis, and they often have relatively long maturities of ten or thirty years. Furthermore, announcements of such offerings appear along with announcements of corporate bond offerings in financial publications. In 1992, thirty-one corporations issued $7.14 billion of MTNs in large, discrete, underwritten offerings, compared with less than $1 billion between 1983 and 1989 (chart 3).

Despite the similarities to corporate bonds, these large, discrete, underwritten securities technically are MTNs because they are issued from MTN shelf registrations. To most investors, this technical difference is largely irrelevant because the securities have the essential features of corporate bonds. As a result, the securities reportedly do not command a yield premium relative to the yield on corporate bonds.

As large, discrete offerings of MTNs have become more common, the distinction between MTNs and corporate bonds has blurred. As a result, the arguments for financing with MTNs have become more compelling. By setting up an MTN program, a corporation does not give up the advantages of issuing large, underwritten securities that typically would be accomplished with a corporate bond offering. However, unlike a shelf registration for corporate bonds, an MTN program gives the corporation the flexibility to issue in small amounts continuously and to participate more actively in structured transactions.

Distribution through Regional Dealers

Through the mid-1980s, the major New York investment banks distributed nearly all MTNs to investors. As the market has matured, regional dealers have placed an increasing volume of MTNs. According to market estimates, placements through regional dealers now account for 5 to 15 percent of MTN issuance volume. In these placements, regional dealers receive information about issuers' offering rate schedules from MTN agents. In turn, the regional dealers communicate this information to their investor clients. When an investor buys an MTN through a regional dealer, the regional dealer receives a selling concession from the MTN agent. Placements through regional dealers improve efficiency in the market by broadening the investor base for MTNs. Many regional dealers have contacts with smaller institutional investors, such as small banks, municipalities, and individuals with high net worth, that represent a relatively stable source of funding.

Distribution of MTNs with Small

Denominations to "Retail" Investors

When the market first developed, most MTNs were sold primarily to institutional investors. Indeed, most MTN programs had minimum denominations of $100,000, which precludes small investors, sometimes called retail investors, from purchasing MTNs. In addition, some issuers declined to issue MTNs in denominations below $1 million because bookkeeping and administrative costs become more burdensome with smaller offerings. In recent years, however, book-entry clearing through DTC and advances in computer bookkeeping have decreased the cost of issuing in small denominations. As a result, many issuers have registered MTN programs with minimum denominations of $1,000, the standard in the corporate bond market. Although most MTNs are still sold to institutional investors, the lowering of minimum denominations has broadened the investor base to include smaller investors. Regional dealers place a significant proportion of the smaller offerings with small institutional investors.

Several MTN programs have recently been designed specifically to tap the retail market without significantly increasing the administrative costs to issuers. The process of issuing retail MTNs may differ slightly from that of MTNs sold to institutions. In one type of retail MTN program, an issuer will post rates weekly with retail brokers. For example, an issuer might post a rate of 4 percent for two-year MTNs and 5 percent for five-year MTNs. During the week that these rates are posted, regional brokerage firms market the securities to retail investors, who place orders in minimum denominations of $1,000. At the end of the week, the regional brokerage firms will contact the corporate issuer and indicate the aggregate volume of orders for notes at each maturity, and the corporation will issue one security at each maturity. In the example, several hundred retail investors could place orders for MTNs with maturities of two and five years, but the administrative costs for the corporate issuer would reflect only two issues from the shelf registration. While this system has the potential to broaden the investor base for MTNs, the size of the retail MTN market is still small relative to the institutional market.

Although the size of MTN offerings has always varied considerably, the variation has become wider as a result of developments in the distribution of MTNs. In 1992, the size of MTN offerings ranged from less than $5,000 to more than $500 million (chart 4). In terms of dollar volume, about 65 percent of MTNs had an issue size between $5 million and $100 million. However, several firms have issued a large volume of MTNs with denominations of less than $5 million. While these offerings account for less than 5 percent of the dollar volume of total proceeds, they represent 45 percent of the number of issues.

EURO-MTNS

MTNs have become a major source of financing in international financial markets, particularly in the Euro-market. Like Euro-bonds, Euro-MTNs are not subject to national regulations, such as registration requirements.(16) Although Euro-MTNs and Euro-bonds can be sold throughout the world, the major underwriters and dealers are located in London, where most offerings are distributed.

Although the first Euro-MTN program was established in 1986, the market represented a minor source of financing throughout the 1980s. In the 1990s, the Euro-MTN market has grown at a phenomenal rate, with outstandings increasing from less than $10 billion in early 1990 to $68 billion in May 1993 (chart 5). New borrowers account for most of this growth, as a majority of the 190 entities that have established Euro-MTN programs did so in the 1990s. As in the U.S. market, flexibility is the driving force behind the rapid growth of the Euro-MTN market. Under a single documentation framework, an issuer with a Euro-MTN program has great flexibility in the size, currency denomination, and structure of offerings. Furthermore, reverse inquiry gives issuers of Euro-MTNs the opportunity to reduce funding costs by responding to investor preferences.

The characteristics of Euro-MTNs are similar, but not identical, to MTNs issued in the U.S. market. In both markets, most MTNs are issued with investment-grade credit ratings, but the ratings on Euro-MTNs tend to be higher. In 1992, for example, 68 percent of Euro-MTNs had Aaa or Aa ratings, compared with 13 percent of U.S. corporate MTNs. In both markets, most offerings have maturities of one to five years. However, offerings with maturities longer than ten years account for a smaller percentage of the Euro-market than of the U.S. market. In both markets, dealers have committed to provide liquidity in the secondary market, but by most accounts the Euro-market is less liquid.

In many ways, the Euro-MTN market is more diverse than the U.S. market. For example, the range of currency denominations of Euro-MTNs is broader, as would be expected. The Euro-market also accommodates a broader cross-section of borrowers, both in terms of the country of origin and the type of borrower, which includes sovereign countries, supranational institutions, financial institutions, and industrial companies. Similarly, Euro-MTNs have a more diverse investor base, but the market is not as deep as the U.S. market.

In several respects, the evolution of the Euro-MTN market has paralleled that of the U.S. market. Two of the more important developments have been the growth of structured Euro-MTNs and the emergence of large, discrete offerings. Structured transactions represent 50 percent to 60 percent of EURO-MTN issues, compared with 20 percent to 30 percent in the U.S. market. In the Euro-MTN market, many of the structured transactions involve a currency swap in which the borrower issues an MTN that pays interest and principal in one currency and simultaneously agrees to a swap contract that transforms required cash flows to another currency. Most structured Euro-MTNs arise from investor demand for debt instruments that are otherwise unavailable in the public markets. To be able to respond to investor driven structured transactions, issuers typically build flexibility into their Euro-MTN programs. Most programs allow for issuance of MTNs with unusual interest payments in a broad spectrum of currencies and with a variety of options.

Large, discrete offerings of Euro-MTNs first appeared in 1991, and about forty of these offerings occurred in 1992. They are similar to Euro-bonds in that they are underwritten and are often syndicated using the fixed-price reoffering method. As a result of this development, the distinction between Euro-bonds and Euro-MTNs has blurred, just as the distinctions between corporate bonds and MTNs has blurred in the U.S. market.

The easing of regulatory restrictions by foreign central banks has played an important role in the growth of the Euro-MTN market. For example, over the past year MTNs denominated in deutsche marks have emerged as a major sector in the Euro-market as a result of regulatory changes made by the Bundesbank in August 1992. Under the previous rules, foreign borrowers could only issue debt denominated in deutsche marks through German subsidiaries or other German financial firms, and maturities could not be shorter than two years. Debt denominated in deutsche marks also had to be listed on a German exchange, and these offerings were subject to German law, clearing, and payment procedures. These rules effectively precluded issuers from establishing multicurrency Euro-MTN programs with a deutsche mark option.

In the August 1992 deregulation, the Bundesbank removed the minimum maturity requirement on debt denominated in deutsche marks issued by foreign nonbanks, and it eliminated or simplified issuance procedures for all issuers. Although the new rules require that a "German bank" act as an arranger or dealer, the definition is broad enough to include German branches and subsidiaries of foreign banks. The arranger is required to notify the Bundesbank monthly of the volume and frequency of issues denominated in deutsche marks. As a result of the Bundesbank's deregulation, from 1991 to 1992, the share of Euro-MTN offerings denominated in deutsche marks increased from 1.4 percent to 4.8 percent, while the volume of issuance in deutsche marks rose from $268 million to $1.69 billion. Other central banks have instituted similar liberalizations that may result in rapid growth of MTNs denominated in other currencies, such as the Swiss franc and the French franc.

OUTLOOK FOR THE MTN MARKET

Few innovations in finance have been as successful as the medium-term note. Its success derives from its remarkable adaptability to the needs of both borrowers and investors. The success can be measured by the number of borrowers, the diversity of note structures, and the amount of outstanding MTNs, all of which have increased dramatically over the past decade.

The adoption of SEC Rule 415 in 1982 was the key event that removed the regulatory impediments to continuous offerings of corporate notes. Other regulatory changes, such as SEC Rule 144A and liberalizations by European central banks, have been instrumental in the development of new sectors in the MTN market. As a result of these regulatory changes, financial markets have become more efficient. In 1992, the SEC eased restrictions on the types of securities eligible for shelf registration. As a result of this ruling, asset-backed MTNs may emerge as the next major growth sector in the public MTN market.

(1.) The Federal Reserve Board conducts a survey of borrowing by U.S. corporations in the public MTN market, the largest sector of the worldwide market. The Federal Reserve collects these data to improve its estimates of new securities issues of U.S. corporations, as published in the Federal Reserve Bulletin, and to improve estimates of corporate securities outstanding, as shown in the flow of funds accounts. (2.) Material in this and the next two sections was originally presented in "Corporate Medium-Term Notes," Leland Crabbe, The Continental Bank Journal of Applied Corporate Finance, vol. 4 (Winter 1992), pp. 90-102. (3.) For example, MTNs have been callable, putable, and extendible; they have had zero coupons, step-down or step-up coupons, or inverse floating rates; and they have been foreign currency denominated or indexed, and commodity indexed. (4) The most common indexes for floating-rate MTNs are the following: the London interbank offered rate (LIBOR), commercial paper, Treasury bills, federal funds, and the prime rate. MTN programs typically give the issuer the option of making floating-rate interest payments monthly, quarterly, or semiannually. (5) SEC-registered MTNs have the broadest market because they have no resale or transfer restrictions and generally fit within an investor's investment guidelines. (6) Financing strategies vary among the borrowers. Some corporate treasurers prefer to "go in for size" on one day with financings in the $50 million to $100 million range, reasoning that smaller offerings are more time consuming. Furthermore, a firm may be able to maintain a "scarcity value" for its debt by financing intermittently with large offerings, rather than continuously with small offerings. Other treasurers prefer to raise $50 million to $100 million over the course of several days with $2 million to $10 million drawdowns. These corporate treasurers argue that a daily drawdown of $50 million is an indication that they should have posted a lower offering rate. In regard to the posting of offering rates, some treasurers post an absolute yield, while others post a spread over Treasuries, usually with a cap on the absolute yield. A few active borrowers typically post rates daily in several maturity sectors; less active borrowers post only in the maturity sector in which they seek financing and suspend postings when they do not require funds. (7) Apart from the distribution process, MTNs have several less significant features that distinguish them from underwritten corporate bonds. First, MTNs are typically sold at par, while traditional underwritings are frequently sold at slight discounts or premiums to par. Second, the settlement for MTNs is in same-day funds, whereas corporate bonds generally settle in next-day funds. Although MTNs with long maturities typically settle five business days after the trade date (as is the convention in the corporate bond market), MTNs with short maturities sometimes have a shorter settlement period.

Finally, semiannual interest payments to noteholders are typically made on a fixed cycle without regard to the offering date of the maturity date of the MTN; in contrast, corporate bonds typically pay interest on the first or fifteenth day of the month at six-month and annual intervals from the date of the offering. The interest payment convention in the MTN market usually results in a short or a long first coupon and in a short final coupon. Consider, for example, an MTN program that pays interest on March 1 and September 1 and at maturity of the notes. A $100,000 MTN sold on May 1 with a 9 percent coupon and a fifteen-month maturity from such a program would distribute a "short" first coupon of $3,000 on September 1, a full coupon f $4,500 on March 1, and a "short" final coupon of $3,750 plus the original principal on August 1 of the following year. Like corporate bonds, interest on fixed-rate MTNs is calculated on the basis of a 360-day year of twelve 30-day months. (8.) Commissions to MTN agents typically range from 0.125 percent to 0.75 percent of the principal amount of the note sale, depending on the stated maturity and the credit rating assigned at the time of issuance. Fees to underwriters of bond offerings are somewhat higher. (9.) The administrative costs may be lower with MTNs than with bonds. After the borrower and the investor have agreed to the terms of a transaction in the MTN market the borrower files a one-page pricing supplement with the SEC, stating the sale date, the rate of interest, and the maturity date of the MTN. In contrast, issuers of corporate bonds sold from shelf registrations are required to file a prospectus supplement. (10.) These yield spreads are estimated using the model presented in Leland E. Crabbe and Christopher M. Turner, "A Dynamic Linear Model of the Determinants of Yield Spreads on Fixed-Income Securities," (Board of Governors of the Federal Reserve System, working paper, June 1993). (11.) An additional reason for the high credit quality of structured MTNs is that some investors, such as money market funds, face regulatory restrictions on the credit ratings of their investments. See Leland Crabbe and Mitchel A. Post, "The Effect of SEC Amendments to Rule 2a-7 on the Commercial Paper Market," Finance and Economics Discussion Series 199 (Board of Governors of the Federal Reserve System, May 1992). (12.) Banks also issue bank notes with shorter maturities that range from seven days to one year. These short-term bank notes are sold to money market investors with interest calculated on a CD basis or discount basis. As with medium-term bank notes, short-term bank notes are issued at the bank level, and they are not insured. Short-term bank notes differ from commercial paper in that commercial paper is an obligation of the bank holding company. (13.) These figures on issuance and outstandings are not directly comparable with those reported in the Federal Reserve's survey because the DTC totals include bank notes and deposit notes issued by banks, as well as MTNs issued by foreign corporations. (14.) See Mark S. Carey, Stephen D. Prowse, John D. Rea, and Gregory F. Udell, "Recent Developments in the Market for Privately Placed Debt," Federal Reserve Bulletin, vol. 79 (February 1993), pp. 77-92. (15.) Besides meeting the securities test, banks and savings and loans must also have a net worth of at least $25 million. In contrast to other investors, broker-dealers must own only $10 million of securities. (16.) Bonds and MTNs may be classified as either domestic or international. By definition, a domestic offering is issued in the home market of the issuer. For example, MTNs sold in the United States by U.S. companies are domestic MTNs in the U.S. market. Similarly, MTNs sold in France by French companies are domestic MTNs in the French market. Bonds and MTNs sold in the international market can be further classified as foreign or Euro. Foreign offerings are sold by foreign entities in a domestic market of another country. For example, bonds sold by foreign companies and sovereigns in the U.S. market are foreign bonds, known as "Yankee bonds." Euro-bonds and Euro-MTNs are international securities offerings that are not sold in a domestic market. As a practical matter, statisticians, tax authorities, and market participants often disagree about whether particular securities should be classified as domestic, foreign, or Euro.