Corporate Bonds and Yield Analysis
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Questions and Answers

What are the typical types of debt discussed?

  • Public debt and private debt (correct)
  • Federal debt and corporate debt
  • Short-term debt and long-term debt
  • Bond debt and equity debt

What is the yield to maturity for a zero-coupon bond primarily based on?

  • The coupon payments of the bond
  • The bond’s face value only
  • The market price of the bond (correct)
  • The interest rates set by the Fed

Under what condition does a bond trade at a premium?

  • When it has a long time to maturity
  • When its yield equals the market rate
  • When its coupon rate exceeds its yield to maturity (correct)
  • When it is newly issued

What happens to bond prices when interest rates rise?

<p>Bond prices decrease (A)</p> Signup and view all the answers

How are zero-coupon bonds impacted as they approach maturity?

<p>Their price approaches the face value (D)</p> Signup and view all the answers

If a bond's coupon rate equals its yield to maturity, what is its trading status?

<p>Trading at par (B)</p> Signup and view all the answers

Which of the following bonds is most sensitive to fluctuations in interest rates?

<p>Long-term zero-coupon bonds (B)</p> Signup and view all the answers

What is the relationship between changes in market interest rates and bond prices?

<p>Bond prices fall when interest rates rise (B), Bond prices rise when interest rates decrease (D)</p> Signup and view all the answers

What does the bond's yield to maturity (YTM) indicate over its life?

<p>It fluctuates as the bond price converges to face value. (D)</p> Signup and view all the answers

What risk is associated with a bond issuer not making full payments?

<p>Default or credit risk (D)</p> Signup and view all the answers

How is the expected return of a corporate bond calculated?

<p>Risk-free rate plus risk premium (D)</p> Signup and view all the answers

What does the credit spread represent?

<p>The difference between yields on Treasury securities and corporate bonds. (D)</p> Signup and view all the answers

What is a primary factor that causes yield spreads to fluctuate?

<p>Investors' appetite for risk (A)</p> Signup and view all the answers

What was the total existing debt of Hertz Corporation that needed to be refinanced in mid-2005?

<p>$9.1 billion (D)</p> Signup and view all the answers

Who led the private investment group to purchase Hertz Corporation?

<p>Clayton, Dubilier &amp; Rice (CDR) (B)</p> Signup and view all the answers

What is the relationship between yield to maturity and expected cash flows of a bond?

<p>Yield to maturity is greater than expected cash flows. (B)</p> Signup and view all the answers

What happens to the stock when call options are exercised?

<p>The stock is obtained from the secondary market. (C)</p> Signup and view all the answers

How do warrants affect the value of original equity when exercised?

<p>They potentially dilute the value of original equity. (A)</p> Signup and view all the answers

Why can't investment bankers use the Black-Scholes model for warrants?

<p>Warrants involve newly issued shares which complicates valuation. (D)</p> Signup and view all the answers

In comparison to convertibles, warrants generally have:

<p>Shorter maturities and are non-callable. (D)</p> Signup and view all the answers

What characterizes mezzanine financing?

<p>It provides rights to convert to equity in case of default. (B)</p> Signup and view all the answers

What is the typical interest rate range for mezzanine financing?

<p>12 to 20% (A)</p> Signup and view all the answers

Why might firms issue debt with warrants instead of convertibles?

<p>They are typically smaller and riskier companies. (B)</p> Signup and view all the answers

When warrants are not exercised, what remains outstanding?

<p>The accompanying debt. (C)</p> Signup and view all the answers

What is the primary advantage of syndicated loans over traditional bilateral loans?

<p>Syndicated loans are less expensive and more efficient to administer. (D)</p> Signup and view all the answers

What does the term 'default risk' refer to?

<p>It is the likelihood of a borrower’s inability to pay interest or principal on time. (D)</p> Signup and view all the answers

In the context of a syndicated loan, what is meant by 'seniority'?

<p>It indicates where an instrument ranks in priority of payment. (A)</p> Signup and view all the answers

Which of the following best describes 'loss-given-default risk'?

<p>The severity of loss a lender may experience if the borrower defaults. (C)</p> Signup and view all the answers

What are the four primary purposes for which issuers utilize loan proceeds from syndicated loans?

<p>M&amp;A transactions, recapitalization, refinancing debt, and general corporate purposes. (A)</p> Signup and view all the answers

What is the main purpose of the road show during an IPO?

<p>To promote the company and explain the offer price to potential investors. (C)</p> Signup and view all the answers

What trend is observed in the number of IPOs based on market conditions?

<p>The number of IPOs is highly cyclical, increasing in good times and decreasing in bad times. (C)</p> Signup and view all the answers

Which type of syndication involves an arranger guaranteeing the entire commitment?

<p>Underwritten deal (D)</p> Signup and view all the answers

What is a 'club deal' in the context of syndicated loans?

<p>A syndicated loan involving a small number of pre-selected lenders. (C)</p> Signup and view all the answers

What typically happens to IPOs on their first day of trading?

<p>They are often underpriced, leading to a higher price at the end of the trading day. (D)</p> Signup and view all the answers

In a typical payment structure during bankruptcy, who is paid first?

<p>Secured creditors (D)</p> Signup and view all the answers

Who primarily participates in expressing interest during the IPO process?

<p>Institutional investors such as mutual funds and pension funds. (B)</p> Signup and view all the answers

How is the final IPO price determined from the initial price range?

<p>Based on the feedback received during the road show from institutional investors. (B)</p> Signup and view all the answers

What is one key benefit of mezzanine financing for borrowers?

<p>Interest may be deferred, making it more manageable. (A)</p> Signup and view all the answers

In mezzanine financing, what may lenders receive in addition to interest payments?

<p>Warrants for purchasing equity. (C)</p> Signup and view all the answers

How do operating leases differ from finance leases?

<p>Ownership risks are transferred to lessee in finance leases. (B)</p> Signup and view all the answers

Which statement best describes a characteristic of leasing?

<p>Leased assets act as collateral within the leasing contract. (B)</p> Signup and view all the answers

What effect does mezzanine financing have on an investor's potential rate of return?

<p>It may significantly increase the investor's rate of return. (D)</p> Signup and view all the answers

What impact does IFRS 16 have on lease expense treatment?

<p>It replaces straight-line operating lease expense with a depreciation charge. (C)</p> Signup and view all the answers

What is a potential disadvantage of mezzanine financing for owners?

<p>Sacrifice of control and upside potential. (B)</p> Signup and view all the answers

What distinguishes an operating lease from other types of leases?

<p>It is essentially a rental contract for temporary use. (C)</p> Signup and view all the answers

Flashcards

Syndicated Loan

A loan provided by a group of lenders, arranged and administered by banks called arrangers.

Default Risk

The probability that a borrower will fail to make timely interest or principal payments.

Seniority

A ranking of how creditors are paid in case of bankruptcy or default. Senior creditors are paid first, junior creditors last.

Loss-Given-Default Risk

The amount of potential loss a lender could face if a borrower defaults. This is assessed based on collateral backing the loan and other debt.

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Target Spread

A commercial loan offered at a specific interest rate, with lenders making commitments based on the rate.

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Underwritten Syndication

Arrangements where arrangers guarantee the entire loan amount to be funded.

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Best-Efforts Syndication

Syndications where arrangers commit to underwrite less than the full loan amount.

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Club Deal

Smaller loans pre-marketed to a group of relationship lenders, usually with close ties to the borrower.

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Zero-coupon bond

A bond that doesn't make regular interest payments (coupons) and only pays the face value upon maturity.

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Yield to Maturity (YTM)

The rate of return an investor can expect to receive on a bond if held until maturity.

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Zero-coupon yield curve

A curve plotting the yield to maturity of risk-free zero-coupon bonds against their maturity dates.

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Coupon bond

A bond that pays regular interest payments (coupons) until maturity.

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Premium bond

A bond trading at a price higher than its face value. This occurs when the coupon rate is greater than the YTM.

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Discount bond

A bond trading at a price lower than its face value. This occurs when the coupon rate is lower than the YTM.

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Bond price convergence

The price of a bond converges towards its face value as it approaches maturity.

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Bond price sensitivity to YTM

When YTM increases, bond prices decrease. When YTM decreases, bond prices increase.

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Credit Spread

The difference between the yield on Treasury bonds and the yield on corporate bonds. It reflects the additional risk investors demand for holding corporate debt compared to risk-free government bonds.

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Expected Return vs. YTM

The yield to maturity (YTM) of a bond is calculated based on the promised cash flows, but the expected return takes into account the possibility of default. The expected return is typically lower than the YTM due to this default risk.

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Bond Rating System

Rating agencies like Moody's and S&P assess the creditworthiness of corporate bonds based on their financial health and ability to meet obligations. These ratings help investors understand the level of credit risk associated with a particular bond.

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Debt Default

The process by which an issuer fails to make a bond payment in full.

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Bond Price Fluctuation

The fluctuation in a bond's price due to changes in the yield to maturity over the life of the bond. As interest rates rise, the value of existing bonds falls to compensate for the lower return.

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Corporate Bond Expected Return

It represents the risk-free rate of return plus a risk premium that compensates investors for the credit risk associated with a specific corporate bond.

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Key Difference: Call Options vs. Warrants

When call options are exercised, the shares come from the secondary market. When warrants are exercised, the shares are newly issued, diluting the value of existing shares.

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Warrants: Not Callable

Warrants are not callable, meaning the issuer can't force conversion before maturity. This gives investors more flexibility.

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Maturity Difference: Warrants vs. Convertibles

Warrants typically expire before their accompanying debt matures, unlike convertibles where debt is fully converted to stock.

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Debt-Plus-Warrant Issuer's Focus

Debt-plus-warrant issuers prioritize debt over equity, suggesting they are more focused on raising capital through debt. This is often seen in smaller, riskier companies.

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Mezzanine Financing: Debt-Equity Hybrid

Mezzanine financing is a hybrid of debt and equity, giving the lender the right to convert to equity in case of default.

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Mezzanine Financing: Low Due Diligence, No Collateral

Mezzanine financing involves little due diligence and collateral, treated as equity on the balance sheet.

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Mezzanine Financing: High Risk, High Return

Typical mezzanine financing interest rates range from 12% to 20%, making it a high-risk, potentially high-return debt form.

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Who Uses Mezzanine Financing?

Mezzanine financing is typically used by companies that need capital but may not have the best creditworthiness.

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Road Show

The process where a company's leadership and underwriters promote the IPO to institutional investors, gathering interest and orders at various prices.

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How IPO Price is Set

The final IPO price is determined based on demand from institutional investors during the road show. The price is set to ensure the most shares are sold while also potentially leaving some shares for later investors.

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IPO Underpricing

A situation where the IPO price is set lower than the market value on the first trading day, leading to a sudden increase in price.

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Cyclical Nature of IPOs

The issuance of new stocks fluctuates with economic conditions; more IPOs are seen when markets are strong, and fewer during downturns.

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Factors Influencing IPO Quantity

Factors like the company's prospects, industry trends, and market conditions influence the number of IPOs in the market at any given time.

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Mezzanine Financing

A type of debt financing where lenders provide capital to a company in exchange for a combination of debt and equity features, usually with a higher interest rate than traditional loans.

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Equity Participation in Mezzanine Financing

Mezzanine finance providers may receive equity in the company or options (warrants) to purchase equity at a later date, giving them potential upside benefits beyond interest payments.

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Leasing

A type of asset-based lending where a lessor (owner) provides the right to use an asset (like a vehicle, equipment, or real estate) for a specific period in exchange for payments. Ownership may or may not transfer to the lessee at the end.

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Finance Lease

Leasing where substantially all the risks and rewards of owning the asset (e.g., maintenance, insurance) are transferred to the lessee, while the lessor remains the legal owner. This is treated like a long-term debt.

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Operating Lease

Leasing designed as a short-term rental contract, where the lessor retains most of the risks and rewards of ownership. This is typically viewed as a form of operating expense.

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Default Risk in Leasing

The potential for a borrower to fail to make timely payments on their debt obligations, which could result in financial losses for the lenders.

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Collateral in Leasing

The value of the collateral backing a loan or lease. This value helps assess the potential loss a lender may face if a borrower defaults.

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IFRS 16 Lease Accounting

The treatment of lease expenses under IFRS 16, moving away from the 'straight-line' operating lease expense to a depreciation charge on the leased asset and interest expense on the lease liability, aligning with finance lease treatment.

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Study Notes

Module Information

  • Course Title: Corporate Finance
  • Course Code: WT 2024/25
  • Instructors: Bamberger / Breitkreuz / Zweigardt
  • Institution: ISM International School of Management GmbH
  • Location: Otto-Hahn-Str. 19, 44227 Dortmund, Germany
  • Website: www.ism.de

Course Content

  • Students will cover fundamental financing principles and optimizing a corporation's capital structure.
  • Topics include financing decisions, financial manager roles, corporate goals, agency problems, and corporate governance principles.
  • Sources of capital will be discussed (debt, bank loans, syndicated loans, private debt, bonds).
  • Hybrid capital includes preferred stock, convertibles, warrants, mezzanine financing, leasing, and factoring.
  • Equity financing and the cost of equity, using models like CAPM and dividend growth models, are key aspects.
  • Capital structure optimization to increase shareholder value by minimizing the weighted average cost of capital (WACC) will be examined.
  • Theoretical knowledge will be connected to real-world situations.

Course Schedule

  • Lectures: 18 hours of presence
  • Self-Study: 42 hours
  • Total Study load: 60 hours per module
  • SWS (Semester Work Units): 2 per Module

Examination Details

  • Written Exam: 90 minutes, 70% of total score, only non-programmable calculators allowed. The original textbook is provided as a reference.
  • Paper Presentation: 30% of total score, students will prepare and present a corporate finance related topic along with solutions to the exercises in the script.
  • Assignment Topics and dates will be provided by lecturer

Table of Contents

  • Introduction:
    • Corporate Investment and Financing Decisions
    • Financial Managers and Opportunity Cost of Capital
    • Goals of the Corporation
    • Agency Problems and Corporate Governance
  • Debt:
    • Bank Loans
    • Syndicated Loan Facilities
    • Private Debt
    • Bonds
    • Cost of Debt
    • Exercises
  • Hybrid Capital:
    • Preferred Stock
    • Convertibles
    • Warrants
    • Mezzanine
    • Leasing
    • Factoring
    • Exercises
  • Equity:
    • Stocks
    • Raising Equity Capital
    • Payout Policy
    • Cost of Equity
    • Exercises
  • Capital Structure:
    • Target Structure
    • Business and Financial Risk
    • Optimal Structure
    • Theoretical Background
    • Empirical Evidence
    • Capital Structure in Practice
    • Exercises

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Corporate Finance WT2024/25 PDF

Description

Explore essential concepts related to corporate bonds, including yield to maturity, interest rate effects, and credit spreads. This quiz delves into how various factors influence bond pricing and investment strategies. Assess your knowledge of bond types and their associated risks.

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