Financial Kingdom of Money and Loans Advice

10Nov

Rising volatility of a credit

Vega-effect (Implied equity volatility): Rising equity volatility will have a positive effect on the price of the convertible bond as it impacts the option component of it. This impact will be strongest in the “balanced”, or in the “equity alternative” territory. Implied equity volatility is also an important part of the Merton option model-based approach of valuing corporate debt, mainly for issues with lower credit quality or in the “Busted convertible” zone. The common definition of the option price sensitivity to the equity price volatility is “vega,” which shows the relative price sensitivity of the option value to a 1 percent move in the implied equity volatility. The “vega” is always positive.

bad debt, business objectives, car loans, compare credit, currency trading, debt consolidation, debt settlement, forex, funds, home equity, investment opportunities, loans guide, portfolio, refinancing

09Nov

The price of a convertible security loan

Before examining the behavior of a typical convertible bond in the different life cycles, the inputs impacting the pricing of convertibles have to be analyzed. Depending on the territory the convertible bond is trading, the following factors will have a different weight explaining the movement:

Delta-effect (Equity price sensitivity): The stock price has a dual impact on the price of a convertible security. Obviously it will have an impact on the price of the embedded call option (higher stock price means higher option value and higher convertible value) especially in the “balanced” and “equity alternative” territory, where the sensitivity of the option to the stock price (common name: delta, which shows the percentage change in the option price caused by a 1 percent change in the share price) is greater than zero. It could have also a spill-over effect on the fixed income value of the convertible in a distressed situation, where the credibility and the potential survival of the issuer is questioned. In this situation the falling share price and the diminishing market capitalization of the company will have a negative impact on its cost of capital, hence on the cost of debt.

business competition, cash reserves, CEO, income, international markets, loans guide, merger, money guide, pricing policy, revenue, shareholders, shares

08Nov

Credit convertibles also have a fixed maturity

Most convertibles pay a regular coupon which is lower than that of a comparable fixed income security (in some cases as low as 0 percent) because of the embedded option value (the bonds are issued at 100 percent, so the lower coupon compensates for the equity option value). Because of this lower coupon the main source of return of a convertible bond is the capital gain. Convertibles also have a fixed maturity (if not converted) and mainly the US-issues have call and/or put dates. Opposed to the normal fixed income securities, convertibles can have a negative yield to maturity (YTM) in cases when the call option is near the money. This could be very important for fixed income investors, as it could adversely impact the YTM of their portfolios.

credit score, get out of debt, income, international markets, merger, money issues, money tips, personal finances, revenue

07Nov

Fixed income securities with payday loans

Plain vanilla convertible bonds are fixed income securities with an embedded equity call option. The price of this instrument changes over time with the underlying stock price of the equity option, equity volatility, credit quality and interest rates. The main difference to other fixed income securities is the incorporated equity call option. This option gives the convertible security holder the right, to convert the bond into a given number of shares of a predetermined security at a previously set date. If it is not converted until maturity, the convertible will be redeemed at a fixed price (100 percent).

bonds, business tips, credit, credit cards, credit score, economy, making money, money management, money tips, payday loans, personal finances

06Nov

Convertible Credit Bonds

There are several reasons for companies to issue convertible bonds. One is to capture the high implied equity volatility in the market (companies issuing convertibles are sellers of the equity call option, so they can save on the coupon payments as they can issue the convertible at a higher volatility level). Another very popular reason to issue this type of securities is to liquidate cross holdings. Especially in the European market exchangeable bonds are a common way for companies looking to monetize their equity holdings in other firms. Convertible bonds generally can save money for the company, as the coupon payment on these securities is below 50 percent of the coupon of straight bonds with same maturity, so companies are able to increase their leverage without affecting the interest costs in the P&L statement. Convertible new issues can have a significant effect on the corporate bond market. The main players in the convertible bond markets are hedge funds (leveraged investors), who buy the convertible new issues, sell the delta-weighted equity position in the name and buy CDS protection to separate the cheap implied volatility in the option value. This causes a widening in the CDS level of the issuer. However, particularly during 2003, many of them let the credit portion of the convertibles unhedged, expressing their view on the credit market (being long credit).

business, credit cards, economy, finances, investments, money advice, money problems, stock, stock exchange

05Nov

Optimal debt ratios

Optimal debt ratios will vary with certain firm-specific and macroeconomic factors. It can be said that a low variance in earnings and lower intangible asset values support higher debt ratios. Higher default risk premiums imply lower optimal debt ratios and vice versa. One fundamental principle of an optimal debt–equity mix is to make the cash flows on debt match up with the cash flows that the firm makes on its assets (e.g. duration and currency mix). Hereby the risk of default is reduced, debt capacity and the value of the firm is increased.

In the case of an underlevered firm, the management should ask itself if the firm has good projects. If this is the case then it makes sense to finance those with debt otherwise dividends should be paid to shareholders or sharebuybacks commenced. Here the problems might start for a company which uses extensive debt financing. If previously good projects turn bad, earnings will not be sufficient to support the high debt levels. As a consequence the firm’s debt profile deteriorates. If a firm is a takeover target then a reasonable strategy would be to increase leverage quickly. On the other hand, in an overlevered firm that has good projects, management should fund those through equity or retained earnings. If the overlevered firm has no projects to finance then retained earnings should be used to pay off debt, dividends should be cut and possibly new equity issued. If such a firm runs the risk of bankruptcy then deleveraging through asset sales or renegotiation with lenders should be the appropriate strategy for management.

crisis, foreclosure, investments, loans, money advice, mortgage, shares, stock, stock exchange, tax, taxes, tenancy, Tenancy-in-Common, tenant, trade value

04Nov

Debt has a tax benefit for loan holders

Debt has a tax benefit as the interest payment is tax deductible (tax benefit = tax rate * interest payment). The costs of debt frequently discussed in economic literature are bankruptcy costs, agency costs and the loss of future flexibility. The cost of debt will depend on:

The general level of interest rates
The default risk premium
The firm’s tax rate.

Cost of equity = Risk-free rate + beta * risk premium After-tax cost of debt = (Risk-free rate + default spread) * (1 – tax)
The cost of capital matters because the value of a firm equals the present value of cash flows to the firm discounted back at the cost of capital. If the cash flows to the firm are held constant and the cost of capital is minimized, the value of the firm will be maximized. With increasing debt levels the cost of equity will increase because equity will become riskier with a rising beta, and the cost of debt will increase with increasing debt levels as well because default risk will go up.

last will, Market, market cycle, market cycles, money, Partnership, payment, price, Private Annuities, property, purchase real estate, shares, tax, taxes, tenancy

03Nov

Financial and credit leverage

Financial leverage (bank debt and bonds) up to a certain point (optimal debt–equity mix) can increase EPS (earnings per share) and ROE (return on equity) but the volatility in EPS will increase as well. As a rule of thumb a debt/capitalization (sum: debt + equity) ratio of around 40 percent is considered to be the optimal capital mix by computing the theoretical equity price.

The following three points shall support the thesis that industrial companies have little incentives to maintain a very conservative capital structure reflected in a AAAor AA-rating category.

The information asymmetry between management and investors favors debt financing over equity financing. If management expects an increase in the stock price it would give away a “free lunch” to new shareholders by issuing equity instead of bonds. If management expects a decline in the equity price and tries to sell equity prior to the fall, it could turn out difficult to sell equity at a fair value because investors might anticipate the decline in the stock price.

An unlevered company will increase its value by taking on debt. This is true because dividend income is fully taxed whereas the interest costs are deductible from corporate taxes. Nevertheless, it is important to notice that an increased gearing (ratio debt/equity) results in a higher risk of financial distress.

heir, income, inheritace, insurance, Interest, joit, last will, Market, market cycle, market cycles, money, rate, tenancy

02Nov

Capital and Credit Structure

Every company tries to optimize its capital structure. The underlying business determines the appropriate leverage. In general, there is a pecking order in the financing decision of every company. Internal financing (retained earnings) is the first form of financing that the management has to consider. If a company is dependent on external financing it will use bank financing before issuing bonds or convertibles. The last form of financing is represented by equity issuance either in an IPO or seasoned issuance (e.g. rights issue) Companies with long-term stable cash flows can increase their leverage without jeopardizing their balance sheet strength. Growth-oriented companies on the other hand should consider a high portion of equity in the capital mix in order to maintain a solid balance sheet structure.

Aids finance, currency cycles, Debt, economics, estate, Estate Planning, heir, income, inheritace, insurance, Interest, rate

01Nov

A sensitivity analysis of the issuer’s loans sources

A sensitivity analysis of the issuer’s sources and uses of cash which considers issuer-specific factors and broad market disruptions has to be performed. The analysis tests the issuer’s ability to cover its cash needs under scenarios with increasing degree of stress. It is useful in understanding an issuer’s sensitivity to unforeseen adverse events, its vulnerability to a restriction of external funding and the time period over which an issuer could withstand a stressed environment.

The financial analysis of a company is not sufficient to evaluate its credit quality but other qualitative factors like the market (business) risk and the assessment of the management quality have to be incorporated into the analysis framework. Execution risk and “bad news” about operating problems can result in a high volatility of spread movements because the future earnings prospects and cash flows are negatively impacted and hence the ability to repay outstanding debt in a timely manner. This leads us to analyze factors affecting the outcome of the business strategy.

annuitant, Annuities, banking, banks, Bearish Patterns, Budgeting, cash, company costs, currency cycles, Debt

« Older Entries