Term
| What is the order of creditor preference in the event of a company bankruptcy? |
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Definition
| Senior Secured (least risk, lowest return), mezzanine/subordinated debt, preferred stock, common stock (most risky, highest return) |
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Term
Difference between bank debt & bonds:
what is the relationship between interest rates of bank debt & bonds? ie, which is higher? |
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Definition
Bank- low interest
Bonds- Higher interest |
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Term
Difference between bank debt & bonds:
Bank Debt: most commonly floating or fixed?
Bond debt: most commonly floating or fixed? |
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Definition
Bank: typically floating (LIBOR plus spread)
Bond: typically fixed at inception |
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Term
Differences between bank debt & bonds:
Typical repayment method:
Bank Debt
Bonds |
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Definition
Bank Debt: typically paid in CASH
Bond Debt: Typically paid in CASH, but MAY be paid in kind |
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Term
Differences between bank debt & bonds:
Amortization of principle:
Bank
Bond |
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Definition
Bank: small amortization
Bond: no amortization |
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Term
Differences between bank debt & bonds:
Prepayment:
Bank
Bond |
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Definition
Bank: typically prepayment is allowed
Bond: typically includes prepayment protection for a certain amount of time |
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Term
Differences between bank debt & bonds:
Typical Collateral
Bank
Bond |
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Definition
Bank: company assets
Bond: typically unsecured but may be secured by assets |
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Term
| What are the benefits & drawbacks of bank debt? |
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Definition
Benefits: Bank debt secured by assets = lower interest rate
Drawback: Typically amortizes = higher payments; may have maintenance covenants |
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Term
| Why might two bonds w/ same maturity, coupon, and issuer, be trading at different prices? |
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Definition
One could be callable, putable, or convertible.
Callable bonds will trade at a discount whereas putable & convertible bonds will trade at a premium |
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Term
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Definition
| A grade given to a bond according to its risk of default |
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Term
| What are the three best known & most trusted rating agencies? |
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Definition
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Term
| Current Events: Why have rating agencies faced skepticism regarding their rating techniques? |
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Definition
| Many of the Mortgage Backed Securities rated by the firms were given very high credit ratings but defaulted at a rate they should not have |
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Term
| What is the YTM on a bond? |
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Definition
Yield To Maturity:
The rate of return on a bond if it is purchased today for its current price & held through its maturity date AND is paid off in full at maturity |
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Term
| How is YTM rate typically expressed? |
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Definition
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Term
| what factors are taken into account when calculating YTM? (ie. what are the inputs to determine YTM) |
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Definition
| current market price, face value, coupon payments, and time to maturity |
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Term
| If coupon yield is lower than current/market yield, will the bond be selling at a premium or discount? |
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Definition
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Term
| If coupon yield is higher than current/market yield, will the bond be selling at a premium or discount? |
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Definition
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Term
| What is the difference between Yield to Maturity and Yield to Worst? |
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Definition
| YTM assumes the debt holder will maintain investment through maturity collecting all interest and being repaid in full at maturity. Yield to worst is the lowest potential yield an investor can earn on a debt investment short of default: ie, if bond is callable or has other provisions what is the yield to call or other provision |
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Term
| What will happen to the price of a bond if the Fed raises interest rates? |
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Definition
| interest rates rise mean newly issued bonds offer higher yields to keep place, making existing bonds less attractive which then must fall in price to raise the yield to the same as new debt issues |
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Term
| What is a Eurodollar bond? |
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Definition
| A bond issued by a foreign company but denominated in US Dollars |
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Term
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Definition
| A bond with a price (or prices) built into the bond indenture that allows the issuer to buy back the bond on a certain date (or dates) usually for a premium over the face value of the bond |
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Term
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Definition
| The bond gives the owner of the bond the right to force the issuer to buy back the security (usually at face value) prior to maturity |
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Term
| What is a convertable bond? |
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Definition
| The indenture specifies a number of shares of stock that each bond can be converted into at a time of the bondholders' choosing |
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Term
| What is a perpetual bond? |
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Definition
| A bond that pays a coupon payment indefinitely (or until the company goes into default) and never returns the principle |
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Term
| When should a company issue debt instead of equity? |
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Definition
| If the cash flow allows, it is typically cheaper to offer debt due to lower cost of capital and tax shields. Additionally, share dilution is not good. However, if the cash flow is not present then equity or a debt/equity (convertible) mix may be necessary. |
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Term
| If I believe interest rates will fall, should I buy a 10-year coupon bond or a 10-year zero coupon bond? |
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Definition
| Zero coupon is more sensitive to fluctuations in interest rate while the price moves inversely to interest payments. Therefore, if interest rates fall, zero-coupon bond prices will increase more. |
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Term
| What is riskier: 30-year coupon bond or 30-year zero coupon bond? |
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Definition
| 30 year zero-coupon bond as it has a potential for zero cash returned in the event of default. |
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Term
| How does inflation affect creditors? |
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Definition
| Real return = return - inflation; only REAL RETURNS matter. Therefor: an increase in inflation will decrease real return. |
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Term
| What would we expect to happen to bond prices and yields if the stock market crashed? |
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Definition
| Flight to quality- bond price increases which causes yields to fall. |
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Term
| What is the easiest way to determine a companies' credit risk? |
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Definition
| look at its credit rating from S&P, Modies', and Fitch |
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Term
| What company metrics/ratios would we look at when performing analysis |
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Definition
| Current Ratio, Quick Ratio, Interest Coverage Ratio, Leverage Ratio |
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Term
| How is current ratio calculated? What is a "good" number? What does it mean if the number is higher? lower? |
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Definition
| (current assets/current liabilities). The current ratio should be just over one. If it is lower the firm may not be able to pay debts whereas if it is higher then the firm is not managing inventory efficiently. |
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Term
| How is the Quick Ratio calculated? Why is it used? |
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Definition
(Current Assets-Inventories)/(Current Liabilities)
This is a conservative estimate of current ratio that assumes inventories cannot be instantly liquidated to pay off debt. |
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Term
| How is the Interest Coverage Ratio computed? What does this metric tell us? What is a "good" number for a large firm? Small? |
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Definition
| EBITDA/Interest Expense; the company's ability to make its annual interest payments with its annual cash flows; large: 8.5+, small: 12.5+ |
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Term
| How is the Leverage Ratio computed? What does it tell us? |
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Definition
| Total Debt/EBITDA; how many years of cash flow it would take for a company to retire its debt |
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Term
| Why is a firm's credit rating important? |
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Definition
| The lower the credit rating, the higher risk of bankruptcy, according to rating agencies, and therefor the higher its cost of borrowing capital |
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Term
Differences between a corporate bond and a corporate loan:
purpose:
Bond
Loan |
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Definition
| used to finance operations; no difference between bond & loan |
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Term
Differences between a corporate bond and a corporate loan:
Which is more senior? |
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Definition
| Corporate loans are typically senior to corporate bonds |
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Term
| How is a floating interest rate determined? |
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Definition
| At inception, the rate is typically set as a "spread" above LIBOR, with a "LIBOR floor" (ie LIBOR is at .4%, LIBOR floor is 1%, borrower will pay spread + floor) |
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