What it means
A medium-term note sits between short-term borrowing, such as commercial paper, and long-term bonds. The issuer sets up a programme with a ceiling, for example $500,000,000, and files the legal paperwork once.
After that it can sell notes under the programme whenever market conditions look good, with each sale called a tranche. The main attraction is flexibility.
A borrower can issue a small note with a specific maturity to match a particular need, in a chosen currency, with either a fixed or a floating interest rate. Dealers, which are banks that market the notes, also respond to investors who ask for a tailor-made note, a practice called reverse enquiry.
Because the legal documents are already in place, the cost of each new issue is lower than for a standalone bond. That makes MTNs popular with banks, finance companies and large corporations that borrow often.
They also appeal to investors who want a particular maturity that no standard bond offers. For a finance team, the key points are the credit rating of the issuer, the interest rate compared with similar debt, and the match between the maturity of the note and the cash flows it will fund.
The notes appear on the balance sheet as borrowings, with interest recorded as an expense over the life of the note. Costs of arranging the programme are normally spread over the period the notes are outstanding.
One nuance is that the name describes how the notes are sold, not just how long they last. Some programmes include notes with maturities well beyond ten years, and some are structured with features such as interest linked to an index.
Always read the terms of each tranche rather than assuming a standard shape. Pricing is built from a benchmark plus a spread.
The benchmark is usually a government bond yield or a short-term interbank rate matching the note's maturity, and the spread is extra yield the market demands for the issuer's credit risk. When the issuer's rating weakens, the spread widens and new tranches cost more, while notes already issued keep their original coupon.
In practice
Real-world examples.
Example
A finance company needs to fund a car loan book that grows through the year. It issues several small notes under one programme, each with a maturity matched to the loans it supports, rather than launching a new bond every time. The treasury team saves several weeks of work on each tranche because the legal terms are already agreed.
Example
A manufacturer with a subsidiary in Europe wants euro funding for a plant expansion. It issues a euro-denominated tranche under its existing programme, which saves the cost of drawing up fresh documents. The company can also swap the euro proceeds into dollars if it prefers to match its currency exposures.
Example
A pension fund wants a bond maturing in exactly six years to match a known liability. A dealer arranges a tailor-made note with that maturity for a bank issuer, which the fund buys directly. The fund avoids a mismatch between its liability and its assets, which would otherwise force it to sell or reinvest at an uncertain price.
Formula
Calculation
Annual interest = Principal x Coupon rate
Total interest over the life = Annual interest x Number of years
Suppose a company issues a $10,000,000 note under its programme with a 5-year maturity and a 5.00% fixed coupon. Annual interest = 10,000,000 x 0.0500 = $500,000. Total interest over five years = 500,000 x 5 = $2,500,000. At maturity the company repays the $10,000,000 principal, so the total cash paid out over the life of the note is 10,000,000 + 2,500,000 = $12,500,000.Case study
Seen in the real world.
Kestrel Equipment Finance is an illustrative, fictional company that leases machinery to small builders. It sets up a $400,000,000 medium-term note programme and issues its first tranche of $50,000,000 at a 4.80% coupon with a four-year maturity.
Six months later the treasurer sees investors asking for floating-rate paper, so she issues a $30,000,000 floating tranche without any new legal work. By the end of the year, she has raised $120,000,000 across four tranches with four different maturities.
Had Kestrel issued a single bond for the whole amount, it would have paid interest on $120,000,000 from day one, even though the cash was needed gradually. The illustrative lesson is that raising money in stages saved the company interest on money it was not yet using.
Watch out
Common mistakes.
- Assuming every medium-term note matures in exactly the same period, when maturities are chosen for each tranche.
- Treating the programme size as money already borrowed, when it is only the maximum that can be issued.
- Ignoring the issuer's credit rating and looking only at the coupon.
Questions
People also ask.
How is an MTN different from a bond?
A bond is usually a single issue with fixed terms, while an MTN is part of a continuous programme where each tranche can have different terms.
Who buys MTNs?
Typical buyers are insurers, pension funds, banks and asset managers that want a specific maturity or currency.
Are MTNs secured?
Most are unsecured and rely on the issuer's credit, although some programmes include security or guarantees.
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