European High Yield - Relative Value

Question 1

Z-Spread Definition

Answer 1

Zero Volatility Spread
- The constant spread that makes the price of a security equal to the present value of its cash flows when added to the yield at each point of the spot rate treasury curve
- ie. the cash flows are discounted at the appropriate treasury spot rate + Z spread
- Also called the static spread
- z-spread is used by analysts to discover discrepancies in a bond’s Price

Formula: P = Cn/(1 + (rn+z)/2)^2n

Question 2

Net Leverage Definition

Answer 2

Net Leverage = Adj.EBITDA/Net Debt

Net Debt = Total Debt - Cash

Question 3

Relative Value: Z-Spread vs Net Leverage

Answer 3

• Plot of Z-spread against Net-Leverage
• Net leverage signals riskiness with regards to refinancing
• Z-spread is the compensation for bearing that risk
• High z-spread relative to net leverage signals better compensation for the leverage of a firm

Question 4

Relative Value: Z-spread vs LTV

Answer 4

• Higher LTV should be compensated by higher z-spread
• HY Autos - ATLNSA 3.375 26’s at 750:55% spread:LTV

Question 5

LTV Definition

Answer 5

LTV (Loan-to-value)
- assessment of lending risk that financial institutions examine before approving a mortgage
- High LTV ratios - higher-risk loans
- Higher LTV ratios tend to have higher interest rates
- Good LTV should be no more than 80%

FORMULA: LTV = Loan Amount/Appraised property value