Long Term Debt

Question 1

What is a sovereign bond?

Answer 1

A bound issued by countries or regions

Question 2

what is corporate bond?

Answer 2

A bond issued by a company

Question 3

What is a Bearer bond?

Answer 3

The owner has the right on the bond coupons and the principal.

Question 4

What is a registered bond?

Answer 4

The issuer has a list with all holders of its bonds

Question 5

What are unsecured debts?

Answer 5

There is no specific asset pledged as a collateral

Question 6

What are secured debts?

Answer 6

There is a specific asset pledged as a collateral

Question 7

What is meant by seniority, in terms of long term debt?

Answer 7

Seniority - The ranking of which bond to liquidate in case of a bankruptcy

Question 8

What is a subordinated bond?

Answer 8

Subordinated = The bond will be paid back after other bonds. The purpose of this is to protect the first issuers.

Question 9

What are the main risks for a bond-holder?

Answer 9

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 The price will therefore become outdated.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

Question 10

what is meant by an Indenture?

Answer 10

That is a contract between the bond issuer and a trust company representing the bondholders interests = legal document that spells out terms and conditions.

Question 11

What is meant by a line of credit?

Answer 11

• Line of credit - A company will get the opportunity to borrow up to a certain amount under a certain period.

Question 12

What is meant by a Private Placement?

Answer 12

Private placement - related with a higher liquidity risk due to being less liquid. Therefore only offered to a small group of investors.

Question 13

What is meant by a Callable Bond?

Answer 13

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.

Question 14

What is meant by a Sinking fund provision?

Answer 14

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.

Question 15

What is meant by a Recovery rate?

Answer 15

Recovery rate = The percentage we expect to get back in the case of a default

Question 16

What is meant by Price Compression?

Answer 16

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.

Question 17

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?

Answer 17

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

Question 18

Why may firms not exercise their embedded callable bonds?

Answer 18

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

Question 19

Why can’t the B&S model be used to value these calls?

Answer 19

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.

Question 20

What is the callable bond value?

Answer 20

The min of [Call price; PV (Future Cash Flows)]

Question 21

What is meant by a conversion ratio?

Answer 21

Conversion ratio = The number of stocks we can get in a case of a conversion of the bond or several bonds

Question 22

What is a convertible bond?

Answer 22

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.