Questions/Concepts Flashcards
How do bonds work? How can they be bought/sold?
Investors loan a company a certain amount of money at a specified interest rate. Company pays back investor with interest payments, typically semi-annually. Existing bonds can be bought and sold on a secondary market. The face value (secondary price) partly depends on the age of the bond and supply and demand.
How can D/E ratio hide the true risk behind a company’s debt?
D/E ratio includes both current and non-current debt. If One company has .5mil short term debt and 1mil long term debt vs a company with 1mil short term debt and .5mil long term debt, the former will likely have more risk because debt generally costs more the longer you’re holding it. Will be a bigger long term pain on the company’s side (unless the short term debt is able to cripple the company)
Sales vs. Revenue?
Sales is money received from company’s direct operations. Revenue is a larger umbrella that includes supplementary income sources in addition to sales
What is interest risk when it comes to bondholders?
The risk of getting the short end of the stick should interest rates change. If interest rates fall lower than bond’s interest rate, company may prepay (bond callability), wiping skipping remaining interest payments. If interest rates rise, then bondholder is stuck getting lower interest payments than the market. The later the bond’s maturity date, the more inherent interest risk there is. Typically is priced into the bond’s rate/price
Relationship between bond price and interest rates?
If current interest rates rise, the current bonds’ relative lower interest rates don’t look at attractive, therefore buyers aren’t willing to pay as much. If the current interest rates fall, then the existing bonds’ relative higher interest rates look more attractive, and buyers are willing to spend more to get the existing bonds’ higher interest payments
Why are B2B businesses more stable than consumer goods businesses?
B2B is professionals working with other professionals, better researched, more people checking each sides’ decisions. Also, business are here to make money. They will buy from/partner with another company with the expectation to make more money from it in the long term. Consumer goods, however, is more privvy to consumer sentiment, which acts like a bipolar child. Lots of volatility, will change its opinion seemingly out of nowhere, etc.
How can comparing two companies directly competing over one product not be a 1:1 comparison?
If for one company the product is their entire business model, vs for another it’s one small fraction of their revenue and product line offering, it’s not an apples to apples comparison. E.g. Zoom vs. Microsoft Teams. Those products directly compete with one another, but you can only invest in either Zoom or Microsoft. Investing in Microsoft means investing in the product plus the rest of the kitchen sink. Hence, can’t be a direct comparison.
What is the seniority security hierarchy?
Higher up on the totem pole the security is, the higher priority and place in line it has when being paid off in the event of a bankruptcy. The higher ranking securities (typically bonds in this case) have the highest change of being paid back, and the lower ones are more at risk.
From top to bottom:
-Secured Bonds: top priority, backed/secured by collateral)
-Senior Bonds: Anything with ‘Senior’ Title attached ranks higher than Junior/Subordinate debt
-Junior (Subordinate) Bonds: Rank lower than senior, but usually has higher interest rates, hence higher margin safety
-Guaranteed (Insured) Bonds: Insured/backed by a third party, though up to third party to take over repayment of bonds in case of company default
-Convertible Bonds: Option to switch asset class to common stock, though not useful feature if company is undergoing financial stress
-Common Bonds: Openly bought/sold on the secondary market
Who are the most common purchasers of preferred shares and why?
Institutional investors. This is because they are eligible for certain tax deductions that normal investors are not qualified for. They can be purchased as easily as common stock
How do share classes work?
Defined on a per-company basis. Typically utilized such that the owners of a company retain more control. For example, Google has Class A shareholders, which have 1 vote per share. At one point the 2 founders found themselves owning less than majority of shares, so created Class B shares. They count for 10 votes per share, and are mostly held by the 2 founders. Class C are typically held by employees and don’t have any voting rights.
If a company earned twice as much as its interest payments, how does this look from a bond buyer standpoint?
The ratio being 2 is seen as very inadequate.
What are some conditions that could cause a bond to sell for less?
If the current interest rates go up, or if the company’s capitalization structure is setup such that an uncomfortable percentage of the earnings are taken up by interest payments (e.g. 2, super low). This makes the bond inherently risky cause there’s a very small margin of safety for the company to have the ability to pay its bond issuers
How do higher Fed interest rates impact the market (e.g. financial institutions, mREITs, REITs)?
Financial Institutions: New loans now compete against higher rates, which means they overall make more money (if they borrow less money to lend out to people). However, their existing low interest loans will be less valuable. If those loans are mostly long term, lowers their value even more
mREITs: The cost to borrow money goes up, and from there the risk goes up due to higher loan payments. Higher prepayment risk eating more into their margins.
REITs: Debt fuels their operations. If borrowing is more expensive, will eat into their margins too. However if they have a high percentage of reliable tenants, they should be fine, though their growth numbers may be a bit tapered.
Do different industries tend to gravitate towards similar ratios?
No, different sectors/industries can have vastly different ratios. For example, railroad PEs can be over 1000 average, while regional banks average around 5. Many tech companies can have near or higher than a PE ratio of 100 due to being seen as growth companies
