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. 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.
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.

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 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.