Introduction to Debt
Rank the following in order of risk (high to low): Revolver, Senior Secured Notes, Term Loan, Equity, Subordinated Notes
Equity, Subordinated Notes, Senior Secured Notes, Term Loan, Revolver
What size blocks does debt trade in?
1M and 5M
I have $1000 in EV, $500 TLA, $300 Senior Notes, $300 Junior Notes, and $300 in equity. What do the junior notes trade at?
66 cents.
Conceptually, what is YTM?
Single rate such that discounting the CFs gives us market price
More intuitively: it is the amount you need to make each year to return par by maturity.
What does it mean if a TL is quoted as Bid/Ask: 99/100?
They will buy it from you at 99 and sell it to you at 100 (par).
What is the most secure bond rating attainable? What is the threshold between investment grade and non-investment grade?
AAA is highest. BBB-/BB+ is threshold.
What is a yield spread? How are they affected as default rates increase?
Yield spread is the difference between bond yield and underlying treasury. Spreads increase as default rates increase.
HoldCo has equity in OpCo 1. OpCo 1 has $500 in assets and $400 in debt. What is the equity holders recovery?
0.
Bond trading at 90 , maturing in 1 year, 10% Coupon; what is YTM?
2/9 or ~22.2%
What is the difference between a DCM and a LevFin investment banker?
What are three key differences between BSLs and HY bonds?
BSLs: illiquid, floating rate, secured, traded by QIBs
HY Bonds: Liquid, fixed-rate, junior debt, can be traded by retail investors
What are two key precursors to high default rates?
1. Weak economic performance, 2. High amount of low rated bonds, 3. Low capital markets liquidity
HoldCo has $300 in assets and $200 in SSN. HoldCo guarantees OpCo1. OpCo1 has $200 in SSN. What do the notes at OpCo1 trade at?
75 cents.
Bond trading at 88 with 5% coupon maturing in 4 years; what is YTM?
8/95 or ~8.4%
What are two types of subordination?
Contractual and structural subordination
What are the two ways that BSLs can be brought to market? What happens to a BSL after it is brought to market?
1. Fully underwritten 2. Best effort to sell loan
After brought to market, sold in pieces to consortium of banks and traded amongst QIBs.
Invest in the SSN; called the fulcrum security and gets post reorg equity
Let’s say that HoldCo has $100 of unsecured debt and OpCo1 equity, OpCo1 has $100 in unsecured debt and OpCo2 equity, and OpCo2 has $250 in assets and $200 in secured debt (backed by assets). HoldCo has upstream guarantees from OpCo1 and OpCo2. What are the recovery values for HoldCo, OpCo1, and OpCo2?
HoldCo Unsecured: 50 cents.
OpCo1 Unsecured:0
OpCo2 Secured: Par
It assumes you can reinvest coupons at the original yield when in reality yield changes over time.
What does MAKE WHOLE @ 50.000 mean?
The borrower can call the bond early so long as they pay the principal + all future coupons discounted back to today with a discount rate of risk-free rate + 50bps
How does a CLO manager make money?
CLO manager make money on the spread between the HY debt in their portfolio and the secure debt that funds their portfolio. They use largely investment grade debt to fund the purchase of a HY portfolio but are able to do this due to diversification.
Why are debt markets inefficient (3 reasons)?
1. Inequal access to information, 2. Transaction costs prevent trading to equilibrium, 3. Irrational behavior (e.g. forced sellings)
HoldCo has 70% equity in OpCo1 and 100% equity in OpCo2. OpCo1 has $40 EBITDA, 10x multiple, and $300 in debt. OpCo2 has $60 EBITDA, 8x multiple and $500 in debt. OpCo1 guarantees OpCo2.
Would you rather buy all 100 shares of HoldCo at 50 cents or buy OpCo2s bond at 80, maturing in 1 year with a 10% coupon?
Ani will provide a live demo on how to answer this question!
Intuitively (no formula), whats the YTM of a 10% coupon bond trading at 70 maturing in 3 years?
price appreciation: 30/3 = 10
So YTM = Coupon + Price appreciation = ~24%
What is call protection and why does it exist?
Protection against debt being paid back early. An investor is expecting to receive coupons for the foreseeable future and if they are forced to redeploy capital may lose potential earnings. Hence a borrower must pay extra to call debt early.