Leveraged Buyouts & Debt Markets

Question 1

Payment In Kind (PIK)

Answer 1

This is a debt security which simply means that interest payments to the holder of the PIK security take the form of additional securities, rather than cash

Usually used when the borrower has large debt obligations that must be met with cash

It may include a PIK toggle which allows the borrower to pay interest in kind or in cash

• Payment in kind is an accrual to the PIK balance which is added back to the cash flow statement and subtracted in the income statement
• Payment in cash hits the P&L and is not added back in the cash flow statement

Question 2

Original Issue Discount (OID)

Answer 2

Is a form of interest equal to the excess of a debt instrument’s stated redemption price at maturity over its issue price (99 OID versus 100 redemption). It is used to attract bondholders to the security if the coupon is too low (it is an additional form of value)

Zero coupon bonds are perfect examples of securities with OID

• Record the bond on the balance sheet at its discounted value upon issuance
• the OID amortization is added to interest expense (for book purposes). Cash taxes is just the stated interest
• added back for the cash flow statement
• the book value of the bond accretes to its face value over the life the bond (add amort of OID to bond balance)