Four Issues in Microeconomics - Essay Example

Corporations in America follow similar financial decisions to individuals concerning their outstanding debt. Whenever market conditions are favorable corporations look for ways to refinance their debt. The difference between a corporation and an individual is that companies utilize different mechanisms to achieve refinancing. Corporate debt can be refinanced by utilizing a bond mechanism. A bond is a commercial paper sold in the denomination of $1000 to individuals or businesses which allows the corporation to raise money. The bonds have a fixed interest rate called the coupon rate. If market conditions changed corporation can issue a set of bonds at a lower interest rate to eliminate its outstanding bonds and pay less money in the long run.

Downgrading of debt occurs when the chances of recovering the outstanding debt diminish because the debtor has not been paying their payment on time. If a loan goes beyond 90 days without a payment being received the debt is said to have gone into default. At this time the chances of collecting the money go down significantly. From the perspective of an outsider, these financial assets of the bank represent a downgraded asset.

The $700 billion bailout plan targeted these types of downgraded assets which the government would buy up to create greater liquidity in the banking system. Another way downgrading of debt occurs is when corporate debt such as bonds is downgraded by agencies such as Moody’s. Moody’s has a system that gives a grade to the commercial paper issued by banks and governments. If the organization is having financial problems the grade of its outstanding debt is downgraded by Moody’s to protect potential investors. A lower grade means that the financial instrument has higher risk and consequently should pay out a higher interest rate.

Banks are becoming more selective about the loans they give out to medium and large corporations because of the precedent that occur during the last few years in which many companies were not able to pay their obligations. In bad economic times, companies do not generate the same types of revenues as they did before. If the banking industry refuses to fund many of these companies it could have a detrimental effect on the entire economy. Corporations utilized short-term lines of credit to pay their payroll to employers and to pay their suppliers. If this credit is not there many companies will incur the mass layoff of their staff and other companies will suffer the consequence of not getting their invoices for material supplied paid on time or at all if the companies go out of business. The lack of loans will also hurt the capabilities of companies to invest in a new project that increases their production capacity.