Investment Banking Q&A Flashcards
What is high yield debt?
A bond that is rated below investment grade and government bonds. These bonds have a higher default risk and thus command a higher interest rate.
What is unsecured debt?
Any type of debt obligation not secured by some assets.
What are ABL Facilities?
Asset based lending. A loan that is secured by assets as collateral.
What is a Revolving Credit Facility?
Revolving credit is a line of credit where the customer pays a commitment fee and is then allowed to use the funds when needed. It is like a credit card and is used by companies to fund working capital.
What are Senior Bank Loans?
Underwritten by an investment bank and syndicated to institutional buyers. First priority in bankruptcy. Often secured in case of liquidation by company’s assets. Usually have a floating rate based upon LIBOR.
What is Mezzanine Debt?
The basic forms of mezzanine debt are subordinated notes and preferred stock. Usually has a kicker where mezzanine investor can buy a portion of ownership later if desired. Helps fill the gap between senior debt and equity when financing a deal. Say you want to buy a company for $1,000,00 and can pay $200,000 in equity while the rest is covered with normal debt, but you want to pay less equity to try and boost returns? In this case, you might call upon a mezzanine investor so that you don’t have to put $200,000 down.
Why would a company use bank debt rather than high yield bonds?
Bank debt is secured by assets of a company and therefor commands a lower interest rate. Trade off is that bank debt typically has more covenants and restrictions.
When should a company issue equity, rather than debt?
1) Feels the stock price is inflated
2) If new projects may not produce consistent cash flows
3) If company wants to adjust capital structure or pay down debt
4) If senior executives are looking to “cash out”
What are some of the advantages of debt financing?
1) Doesn’t dilute ownership (control)
2) Don’t forgo future profits
3) Tax Shields!
What is PIK interest?
Paid in Kind. Rather than making cash interest payment, the bond/loan will increase in the face value each period by the PIK interest rate.
Why is debt cheaper than equity?
Once you pay off debt the obligation is over, but with equity the obligation is infinite. If you expect the company to perform well than it will likely be more expensive.
What is Amortization?
A feature that may be built into a loan requiring the borrower to pay off the loan over its term rather than paying the entire face value at maturity.
What steps can the Fed take to influence the Economy?
1) Open Market Operations (buying/selling securities to change the money supply)
2) Raising or Lowering Rates
3) Change Reserve Requirements (lower requirement = more loaning)
What is duration?
Measure of sensitivity of the price of bond to a change in interest rates. It is essentially the weighted average maturity of cash-flows over the price of the bond. Measured in years. Main flaw is that it assumes a linear yield-price relationship.
How would you describe the difference between leveraged finance and debt capital markets?
Leveraged Finance typically works with sub-investment grade, high-yield debt instruments where DCM team works with investment grade debt.
The focus of Leveraged Finance are LBO/Acquisitions where DCM is more everyday operations of businesses (although acquisitions also)
Can a company have a negative book equity value?
Yes if giving out large dividends or operating at a loss for a long time
What is Debt-Service-Coverage Ratio?
A leverage ratio equal to Net Operating Income divided by total Debt Service.
A ratio beneath 1.25-1.5 is deemed low (depending on industry)
What is Gross Profit Margin?
A profitability ratio:
= Gross Profit / Revenues
Represents proportion of money left over from revenues after COGS
What is Operating Margin?
A profitability ratio:
= Operating Profit (EBIT) / Revenue
Provides a metric for how much a company makes (before interest and taxes) on each dollar of sales
What is Net Profit Margin?
A profitability ratio:
= Net Income / Revenue
Shows percentage of each dollar in revenue that gets converted into profits
If depreciation is a non-cash expense, why does it affect the cash balance?
It is tax deductible, since taxes are cash expense it has impact on cash flow statement.
Impact = depreciation amount * (1-tax rate)
What happens when inventory increases by $10? Assume you pay with cash.
Income Statement: nothing
Cashflow Statement: decrease cashflow from operations by $10
Balance Sheet: Inventory is up $10 and Cash is down $10
What happens to the three statements when there is a write-down of $100?
Income Statement: $100 write-down shows up on pretax income, with 30% tax rate Net Income decreases by $70
Cashflow Statement: Net Income is down $70, but we add back $100 since the write down is a non-cash expense, overall up $30
Balance Sheet: Write down is decrease in assets by $100 and cash is up $30. Overall down $70 and shareholders equity down $70
A company has had a positive EBITDA for the past 10-years but recently went bankrupt, how could this happen?
1) Spending too much on capital expenditures
2) Company has high interest expense and can’t afford debt
3) Debt all matures at one time and they have a credit-crunch
4) Has significant one-time charges such as a litigation fee
What is the difference between bottom-up vs top-down revenue building?
Bottom-Up: start with individual products/customers, estimate the average sale value or customer value, then growth rate and sales and project from there
Top-Down: start with big-picture metrics such as overall market size, estimate company’s market share and how it will change moving forward, multiply to get revenue
What is the Debt Capital Market?
A low risk capital market where investors are lenders to company in exchange for debt securities. These markets also used by companies to finance themselves through debt which helps diversify funding.
How does one acquire debt securities?
1) Primary Market: where government/corporations directly issue bonds
2) Secondary Market: where individuals who have already received there bond certificates go to resell bonds for higher/lower price (subject to demand)
What are the differences between DCM and ECM?
In Debt Capital Markets investors are lending money to companies where as in Equity Capital Markets investors are purchasing a portion of ownership
Debt Capital Markets usually has lower risk, lower return
In Debt Capital Markets investors expect payments in full, can’t be said for Equity Capital Markets
What is the difference between a Corporate Bond and a Consumer Loan?
Main difference is market they are traded on, bonds are issued and traded on secondary markets
Bond issuance typically for a large amount of capital, is sold on the public market and can be traded
A loan is issued by a bank, usually has floating rates, covenants and is not traded
What is a coupon payment?
The interest payment a company will pay to holders of the bond loan
= interest rate * face amount of bond
What is the difference between an investment grade bond and junk bond?
Investment grade bonds are issued by companies with good credit ratings and low risks of defaulting. Therefor, they have a relatively low rate because they are “safe”.
Junk bonds are issued by a companies that have high risks of bankruptcy but thus has higher interest payments.
How could inflation hurt creditors?
Inflation cuts into the real percentage return that creditors make when they lend money
What is the Current Ratio?
= Current Assets / Current Liabilities
A number slightly above 1.00 means that they are managing inventory efficiently
A ratio below 1.00 means that they are struggling to meet liabilities, whereas a ratio well above (2-3) means that they may not be using enough leverage to expand business
What is the Interest Coverage Ratio?
= EBIT / Interest Expense
Measures a company’s ability to make its annual interest payments with its casfhlows
What is the Leverage Ratio?
= Total Debt / EBITDA
Allows an investor to evaluate how many years of cash-flow it would take for a company to retire its debt
What is Convexity?
The main issue of Duration is that it assumes a perfectly linear relationship between bond yield and price. Convexity is the answer to this problem.
Convexity measures the relationship between bond prices and bond yield. The higher the convexity, the greater the impact interest rate fluctuations have on a portfolio, and the greater the overall risk.
