Lecture 3

Question 1

Loans/ Bonds: How is the level of seniority?

Answer 1

SSL = Senior secured loans

Question 2

Loans/ Bonds: SSL vs. High yield bonds

• floating/ fixed
• tenor
• prepayment
• seniority
• call protection

Answer 2

Question 3

Comparison Loan vs. Bond

• Liquidity
• Default risk
• interest rate risk

Answer 3

Liquidity
- Bond: public traded, more liquid, less yield
- Loan: more illiquid, more yield

Default risk
- Bond: more junior capital, may be unsecured
- Loan: more senior debt, often secured by collateral

Interest rate risk
- Bond: mostly fixed-rate; lower interest rate risk
- Loans: many are callable = can be prepaid at any time + likely to have floating rates

Question 4

Answer 4

Question 5

Question 6

What is the difference between investment grade bonds and high yield?

Answer 6

Investment grade = low credit risk
high yield = higher credit risk

Question 7

Bond: What is considered to do the rating?

Answer 7

Question 8

What kind of covenants do exist? and what are the consequences if they don’t maintain the covenants?

Answer 8

• Affirmative covenant: requirements for the borrower (f.e. maintain a debt service coverage ratio, that requires a minimum income relative to the size of the current year)
• Negative covenant: prohibitions on actions (f.e. not increase the debt)

Consequences
- can be technical default on the loan
- creditor can require repayment or restructure of loan, move collateral or force bankruptcy

Incurrence covenants
- take or not to take a specific action once a specific event occurs (bsp. creditor has to have a certain EBITDA to get further debt)

Maintenance covenants
- stricter than incurrence covenants

Question 9

Capital structure (from SSL to Equity) -> what is inbetween? and what are the targeted returns?

Answer 9

1st lien: 5-8%
2nd lien: 8-11%
mezz: 12-16%
equity: 20%+

Question 10

Bankruptcy: Default rate

Answer 10

measures how many loans or bonds in a portfolio have defaulted

Question 11

Bankruptcy: Recovery Rate

Answer 11

how much of the original loan or bond value can be recovered after a company defaults
-> recovery comes from selling the company’s assets in a bankruptcy process

Question 12

Leveraged Loans: How does the issuance process look like?

Answer 12

Question 13

What is direct lending?

Answer 13

• outside of the traditional banking system
• funding from loans originated by private equity, private credit, and hedge fund lenders
• higher interest rate, because no access to bank loans

Question 14

How do you calculate the weighted average cost of capital (WACC)?

Example

Answer 14

Question 15

Answer 15

Question 16

Answer 16