Debt markets explanation please
Hi guys,
what exactly are the commentators referring to when they say that debt is expensive? Obviously the cost of debt has increased but what specific prices are they referring to - or rather, where is the data coming from? I.e: Do they look at corporate bonds and see that yields (or is it prices?) have gone up? Or are they looking at the cash rate? Or what?
Sorry if this is straightforward but I'm just trying to drill down into the micro-details to get some context. You often hear students talking about all these topical issues but when they get probed about it they really have no idea other than being about to recycle the media's proclamations - which only gets you so far.
Any help would be much appreciated.
Cheers
Debt is expensive when yields (interest rates) are low.
Remember that as the price of a bond rises, its yield declines.
Bonds are expensive right now because yields are historically at all time lows.
Bonds would be "cheap" if the price was low and the yield was high.
Commentators could also mean that debt is expensive for companies to borrow. If they are perceived as risky by the market, then yields will have to be high in order for the market to have appetite for the bond. You have to be careful when listening to commentators. They speak as though they have an audience who already knows what they are getting at and sometimes, as a result, they are not clear.
Expensive debt doesn't have to do only with actual pricing... yes yields may rise 50-150bps making it more expensive but there are more variables that impact "expensiveness" besides pricing; in my opinion they weigh more on the "cost of debt" than interest rates... These are things like amortization of bank debt, more restrictive maintenance covenants, more restrictive borrowing bases, more restrictive indebtedness baskets, etc. These factors weigh more heavily on cash flows / operations that a 1-2% increase in the cost of a senior loan for example.
I think that statement can mean different things. Right now debt is expensive because spreads are high. More volatility and risk in the market have increased the amount corporations pay for debt over libor/risk free rate. A company that paid Libor + 100 BPs now might have to pay Libor + 300 if they went to the market to finance bonds or corporate debt. This view is referring to debt as expensive because of the high spread over LIBOR.
Additionally, someone might say debt is cheap now, simply because interest rates are low. A company used to pay Libor + 100 in the example above. When LIBOR was at 4% they paid 5% interest. Now LIBOR + 300 is more like 3.5% total interest. The actual cash interest payment is now less. Here debt could be described as cheaper. The above example is more common in the market place.
While the previous poster was correct in referencing the inverse relationship between interest rates and bond prices, I don't think that is what the media is talking about. They are talking about debt from the perspective of the companies issuing the debt or for funds looking to lever up.
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