Long Term Debt Flashcards
What is a sovereign bond?
A bound issued by countries or regions
what is corporate bond?
A bond issued by a company
What is a Bearer bond?
The owner has the right on the bond coupons and the principal.
What is a registered bond?
The issuer has a list with all holders of its bonds
What are unsecured debts?
There is no specific asset pledged as a collateral
What are secured debts?
There is a specific asset pledged as a collateral
What is meant by seniority, in terms of long term debt?
Seniority - The ranking of which bond to liquidate in case of a bankruptcy
What is a subordinated bond?
Subordinated = The bond will be paid back after other bonds. The purpose of this is to protect the first issuers.
What are the main risks for a bond-holder?
Main risks of a bond for the bond-holder
• Credit risk/default risk/ counter party risk
• Liquidity risk - a bond that is not being traded in the market will lose in value due to not being liquid. The price will therefore become outdated.
• Inflation risk
• Interest rate risk - in case of increasing interest rate
• Exchange rate risk / currency risk
what is meant by an Indenture?
That is a contract between the bond issuer and a trust company representing the bondholders interests = legal document that spells out terms and conditions.
What is meant by a line of credit?
• Line of credit - A company will get the opportunity to borrow up to a certain amount under a certain period.
What is meant by a Private Placement?
Private placement - related with a higher liquidity risk due to being less liquid. Therefore only offered to a small group of investors.
What is meant by a Callable Bond?
1) We have the option, but not the obligation, to pay back before the maturity.
2) Is a main advantage if the interest rate decreases - will become cheaper for the company to pay back in this case.
What is meant by a Sinking fund provision?
Sinking fund provisions ○ Here we have the credit risk ○ Defaults --> no money back ○ To decrease this risk --> sinking fund ○ The company has the option to pay an amount of money, to a sinking fund, which is a % of the Face value, which will be used to pay back the bond in case of default. A type of safety.
What is meant by a Recovery rate?
Recovery rate = The percentage we expect to get back in the case of a default
What is meant by Price Compression?
Price appreciation in a declining interest environment is limited because the market increasingly expects the bond to be called as it is more beneficial in that state.
In what case would a company pay back earlier in the future and is there any difference between a callable and non-callable bond in that case?
If the interest rate decreases
In case of a decreasing YTM - the callable bond will have a LOWER change in the price than the non-callable bond due to the price compression
Why may firms not exercise their embedded callable bonds?
1) Refunding/transaction cost - don’t have cash in the bank account - borrow money or issue stocks - a lot of transactional costs in case of issuance - maybe that’s why company delay their action of exercising the option
2) Might change the capital structure of the firm - leading to the firm not having an optimal capital structure anymore - they could therefore wait for a better time to do so
Why can’t the B&S model be used to value these calls?
1) The bond price will have a maximum value which isn’t the case for a stock.
2) Bonds depends on interest rates more than stock does.
3) We can also have a seemingly higher strike price than the Face Value of the bond which is not logical –> shows wrong reality.
4) B&S further assumes a constant volatility while this changes for a bond the closer we get to the maturity.
What is the callable bond value?
The min of [Call price; PV (Future Cash Flows)]
What is meant by a conversion ratio?
Conversion ratio = The number of stocks we can get in a case of a conversion of the bond or several bonds
What is a convertible bond?
The option to turn bonds into stocks in the future.
We want to convert when the value of bonds are higher than the value of stocks.
