lecture chaper 24 Flashcards
comparison between debt and equity from the perspective of a potential outside investor (debt)
Investor provides refundable money. She is called debt-holder or creditor
Legal obligation for debtor to repay creditor
If you have debt in a sufficiently profitable firm, it is not risky
But bankruptcy can happen
When a firm goes bankrupt, not even creditors can be repaid in full
Creditors may get a “haircut”
Comparison between debt and equity from the perspective of a potential outside investor Equity
Investor provides non-refundable money. She is called shareholder
Residual claim on future cash flows
Risky: Return from stocks is volatile
It is the type of volatility equity holders cannot diversify away
In the event of bankruptcy, equity may be worth nothing
yield of a bond
the rate of return implied by the price of the bond
Price = PV(coupons and principal, discounted at the yield)
The yield can be interpreted as the required return from investing in the bond
There is a negative relation between yields and prices
When prices are high, yields are low +
When prices are low, yields are high
To see this, note that if investors demand a big return from an investment, they want their buy and hold return (Pricet+1 - pricet)/pricet to be high
one way to obtain this is by paying a lower price. hence, when the yield is high, a bond price is low
Face value or principal amount of a bond
is denominated in standard increments, most often in 1000$
The face value does not always correspond to the actual money raised because of underwriting fees and or if the bond is issued at a discount
More in general the ond can be issued at
A premium (this happens when coupon rate > bond yield)
At par (this happens when coupon-rate = bond yield)
At discount (this happens when coupon-rate < bond yield)
yields are backed out from prices
Take for instance a coupon bond with annual coupon payments
The yield Y on this bond that cash flows discount rate such that Pricecoupon bond =
Price(Coupon bond) = C/Y * (1-1/(1+Y)^t) + F/(1+Y)^t
where C is the coupon $ amount
F is the vace value of the debt
leverage buyout
when a group of private investors purchase all the equity of a public corporation and finances the purchase primarily with debt
The prospectus
a public bond issue is similar to a stock issue
Indenture
Included in a prospectus, it is a formal contract between a bond issuer (a corporation) and a trust company
The trust company represents the bondholders and makes sure that the terms of the indenture are enforced
Inn the ccase of deffault, the trust company represents the interests of the bond holders
senior debt
in the event of a liquidation, senior debt has the highest priority in repaymentSub
Subordinate and junior debt
refer to lower degrees of priority
Asset-backed debt
in the event of bankruptcy/liquidation, the asset that was used as “collateral” for the loan is used to repay the creditor
E.g. mortgages
Unsecured debt:
in the event of bankruptcy/liquidation unsecured bondholders are paid from the sale of assets of the firm that are not already pledged as collateral on other debt
E.g. Notes and debentures
a bond issuer typically repays its bonds by making coupon and principal payments as specified in the bond contract. However the issuer can
repurchase a fraction of the outstanding bonds in the market
Make a tender offer for the entire issue
Exercise a call provision
