Quantitative Analytics in Debt Valuation & Management: A Breakthrough Methodology for Analyzing the High-Yield and Distressed Debt Market
336
Quantitative Analytics in Debt Valuation & Management: A Breakthrough Methodology for Analyzing the High-Yield and Distressed Debt Market
336Hardcover
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Overview
Global advances in technology give investors and asset managers more information at their fingertips than ever before. With Quantitative Analytics in Debt Valuation and Management, you can join the elite club of quantitative investors who know how to use that information to beat the market and their competitors.
This powerful guide shows you how to sharpen your analytical process by considering valuable information hidden in the prices of related assets. Quantitative Analytics in Debt Valuation and Management reveals a progressive framework incorporating debt valuation based on the interrelationships among the equity, bond, and options markets. Using this cutting-edge method in conjunction with traditional debt and equity analysis, you will reduce portfolio risk, find assets with the highest returns, and generate dramatically greater profits from your transactions.
This book’s “fat-free” presentation and easy-to-navigate format jump-starts busy professionals on their way to mastering proven techniques to:
- Determine the “equity risk” inherent in corporate debt to establish the causal relationship between a company’s debt, equity, and asset values
- Price and analyze corporate debt in real time by going beyond traditional methods for computing capital requirements and anticipated losses
- Look with an insider’s eye at risk management challenges facing banks, hedge funds, and other institutions operating with financial leverage
- Avoid the mistakes of other investors who contribute to the systemic risk in the financial system
Additionally, you will be well prepared for the real world with the book’s focus on practical application and clear case studies. Step-by-step, you will see how to improve bond pricing and hedge debt with equity, and how selected investment management strategies perform when the model is used to drive decision making.
Product Details
| ISBN-13: | 9780071790611 |
|---|---|
| Publisher: | McGraw Hill LLC |
| Publication date: | 05/21/2012 |
| Pages: | 336 |
| Product dimensions: | 6.00(w) x 9.10(h) x 1.10(d) |
About the Author
Read an Excerpt
Quantitative Analytics in Debt Valuation & Management
By MARK GUTHNER
The McGraw-Hill Companies, Inc.
Copyright © 2012The McGraw-Hill Companies, Inc.All rights reserved.
ISBN: 978-0-07-179061-1
Excerpt
CHAPTER 1Traditional Techniques in Credit Analysis
Investors who make loans or buy debt securities understand that they are taking on a host of risks in pursuit of maximizing returns on their investments. Most loans will pay off with interest, whereas a few will not. An assessment of those risks is critical to determining an appropriate rate of interest to charge when making a loan or what yield to maturity to demand when purchasing a bond as compensation for the risks taken. These risks fall into three broad categories—market risk, company-specific risk, and political risk. The following is an explanation of these key risks:
• Market risk. There are a number of components of market risk that are endemic to the entire economy. Diversification will not eliminate or reduce this risk. The following is a detailed listing of the components of market risk:
* Interest-rate risk. A loan typically locks in a rate of interest the borrower must pay to the lender over a predefined period. If the general level of interest rates rises after a loan closes, the pricing of new loans will incorporate those higher rates. The value of old loans written at lower rates will fall, raising their yield to maturity to reflect the new market conditions. This puts the old loans with lower coupons on par with a new loan paying a higher coupon. This is interest-rate risk.
* Inflation risk. The purchasing power of currency changes over time. When making a loan, one exchanges currency today for currency in the future and an interest payment along the way. In so doing, the lender takes the risk that the purchasing power of the currency returned in the future will be less than it was on the day the loan closed. Interest-rate and inflation risk are related. When inflation is high, investors will demand a high rate of interest to compensate for the depreciating future value of the currency. In this way, the investor earns more currency to compensate for the fact that the purchasing power of each currency unit will fall in the future.
* Liquidity risk. There are times when an investor will need to sell an investment to raise cash. A mutual fund may have redemptions by its individual investors, depositors at a bank may withdraw funds, and an insurance company may have to pay claims following a natural disaster, for example. In such circumstances, the owner of securities will need to work with a broker to find another investor who is interested in purchasing the securities the owner wishes to sell. The owner of an investment may not be able to sell the asset quickly at its fair value when the need arises because buyers for that particular investment may be scarce. The owner of the investment may need to discount the price of the investment and suffer a loss in value to close a sale. This is liquidity risk.
* Call risk. Some loans allow the borrower to repay the loan before the maturity date. If interest rates fall, the borrower may find it advantageous to refinance by calling the loan and taking out a new one at the lower prevailing rates. Under these circumstances, the lender gets his or her money back but will have to reinvest the proceeds at lower rates, lowering his or her expected future rate of return. In addition, the lender may have to reinvest at an even lower rate than the drop in the general interest rate because market risk premiums may be lower, resulting in lower credit spreads. Furthermore, the lender may not be able to find lending opportunities at the same level of risk, forcing him or her to write a loan to a higher-quality borrower at a lower rate of interest that is below his or her target rate of return. Alternatively, the lender may have to lend to a higher-risk borrower at a higher rate of interest but at a risk level that is higher than he or she desires. This is call risk.
* Reinvestment risk. Reinvestment risk has similar characteristics to call risk, just smaller. As a borrower pays interest on his or her loan, the lender will have to reinvest those funds at the prevailing interest rate. Should the general level of interest rates and risk premiums fall after loan origination, the lender may not be able to reinvest coupon payments at the same rate with the same level of risk as the original loan. In short, the lender may have to reinvest at a lower yield for all the same reasons associated with call risk. This is reinvestment risk.
* Risk premiums. Risky assets require a higher rate of return to compensate the investor for fluctuations in the market value of an investment and the risk of permanent loss. Risk premiums fluctuate continuously, and this affects the valuation of all risky assets. In the case of fixed-income investments, changes in the market risk premium change the credit spread borrowers will have to pay for new loans and change the value of debt instruments already in place.
• Company-specific or unique risk. This is risk associated with a particular company or security. Since this type of risk is inherent to a particular investment and not shared by all investments, diversification will manage and reduce unique risk. The following is a listing of the key elements of company-specific or unique risk:
* Credit risk. Broadly defined, credit risk represents the probability that a borrower may not be able to repay principal and interest as promised. When this occurs, the lender generally loses money. Credit risk consists of two key unknowns: (1) the probability of a default occurring and (2) the amount the lender will recover in a default scenario. Credit risk is not a static risk. After a loan origination, the financial condition of the borrower may decline for a whole host of reasons. It is important to note that the owner of the loan does not have to sell the bond to suffer a loss. The higher risk reduces the value of the loan on a mark-to-market basis. When the lower market price of the loan is accepted, the value lost is recognized. It is certainly possible that the fortunes of the borrower might improve causing the loss to diminish. Alternatively, the loss may be recovered as the loan ages and is eventually repaid. Even though the risk is higher, the borrower still may be able to honor the terms of the lending agreement. Therefore, the investor does not suffer a loss, at least not nominally. Should the owner of the loan wish to sell that loan, he or she will have to work with a broker to find a suitable buyer. Now that the loan has higher credit risk, a potential buyer of the loan will demand a higher yield (credit spread) than was demanded at the time of loan origination. In this case, the mark-to-market loss is crystallized. Changes in the potential for default and the amount one might recover in a default scenario, which change the value of a credit-risky loan, constitute credit risk.
* Event risk. Big changes happen at companies all the time. The possibility of an exogenous one-time event such as an accident, a lawsuit, or a takeover by another company or a private equity firm is ever-present. This also could represent a random periodic event initiated by management, such as a sudden repurchase or sale of stock or some other operating restructuring, such as the selling of a division or the purchase of another company. These events tend to cause a shock to the financial condition of the company, potentially altering the future financial performance of the borrower. Sometimes these shocks affect the value of the firm as a whole. At other times it may result in wealth transfers between lenders and owners. This is event risk.
• Political risk. Companies exist under some governmental jurisdiction. Some governments take a more positive stance toward businesses than others. The a
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Excerpted from Quantitative Analytics in Debt Valuation & Management by MARK GUTHNER. Copyright © 2012 by The McGraw-Hill Companies, Inc.. Excerpted by permission of The McGraw-Hill Companies, Inc..
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Table of Contents
Introduction ix
Chapter 1 Traditional Techniques in Credit Analysis 1
Chapter 2 Loan Valuation Framework 45
Chapter 3 Model Application and Capital Framework 69
Chapter 4 Pricing Individual Loans 95
Chapter 5 Market-Implied Probability of Default 125
Chapter 6 Integrating Equity Prices into Debt Valuation 155
Chapter 7 Hedging Debt with Equity 187
Chapter 8 Real-Time Simulation-A Case Study 223
Chapter 9 Managing Levered Debt Portfolios 253
Chapter 10 Conclusions and Final Thoughts 285
Notes 291
References 297
Index 301