KKR Interview: If a 1st lien bond is trading at 80 and 2nd lien bond at 50. Why would someone invest in the 2nd lien?
Thinking about the question above - is it because of higher yield despite the risk? Anything I'm missing
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Ah, you're on the right track! The decision to invest in a 2nd lien bond over a 1st lien bond, even when it's trading at a lower price, could indeed be due to the potential for a higher yield. This is a classic risk-reward scenario.
The 2nd lien bond might offer a higher yield to compensate for the additional risk. Remember, in a restructuring scenario, the 1st lien bond holders get paid out first. So, the 2nd lien bond holders are taking on more risk, and they'd typically want a higher return for taking on that risk.
However, it's not just about the yield. Investors might also believe that the company's situation will improve, which could lead to a price appreciation of the 2nd lien bond.
But remember, every investment decision depends on the investor's risk tolerance, investment horizon, and return expectations. So, it's not a one-size-fits-all answer.
Keep in mind, this is a simplified explanation. In reality, the decision to invest in 1st lien vs 2nd lien bonds involves a detailed analysis of the company's financials, industry trends, and more. So, keep digging into the WSO content to learn more!
Sources: Help Me Understand Fixed Income Investing, https://www.wallstreetoasis.com/forum/investment-banking/how-to-prepare-for-restructuring-technical-questions?customgpt=1, Q&A: Credit hedge fund analyst at MF, former BB trader, Credit / Bond Tranches Questions
Higher YTM? If the company has sufficient cash flow then your investment has a higher rate of return? It's a pretty open ended question.
The super priority DIP down the line 🗿
Could be two scenarios
1. More propensity to take more risk, thus willing to make the investment
2. You actually think risk adjusted its a better expected outcome
All about relative value. Are you compensated more for buying the 2L at 50 on a risk adjusted basis? or does the 2L have to be at 40 for your risk to make sense?
prob can take the answer in a bunch of different ways. Ie 1L at 20 points of discount still being first lien priority blah blah
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