Debt Valuation

Question 1

Explain 6 forms of debt

Answer 1

1. Debentures- fixed interests paid & low risk
2. Unsecure loan stock- no assets attached, claim against current assets
3. Subordinated loan stock- pay higher capital amount
4. Asset backed securities- attached to tangible assets, may never collect fees
5. Convertibles- debt converted to equity on decision of investor
6. Floating rate notes- using variable rate interest based on rated banks borrow/lend

Question 2

Debt yield curve

Answer 2

Learn diagram

Question 3

Explain debt yield curve

Answer 3

-> depicts relationship between interest rates and length of time to maturity
-> shows how the yield varies for different lengths of time to maturity

Question 4

Theories proposed to explain the shape of the debt yield curve

Answer 4

1. Expectations theory = the financial markets believe that interest rates will increase over the foreseeable future
2. Liquidity preference theory = investors require cash in the short term and need to be compensated for long term investments
3. Market segmentation theory = demand for cash exceed supply

-> these drive interest rates up
-> they are not mutually exclusive explanations. They tend to operate at any one time but with different degrees of pressure