Need help with bonds
1) Given a coupon, a YTM, and a maturity, find the current price of a bond. At what price point do bonds become indicative of distress?
The formula for this is attached. In an interview scenario, how would I go about doing this in my head (will they let me use a pen and paper?).
At what price point do bonds become indicative of distress: I would assume that in distress, the bond holder would want higher yield, so it would be reflected in a lower price? I'm not entirely sure how to tackle this question
2) What is YTW? When evaluating a company in distress, which would you use and why?
Yield-to-worst. I would use YTW because it will be reflective of what the creditor will actually get and what the debtor will have to pay out.
Been getting destroyed at my semester internship, so haven't had time to dig deep in the concepts, need your guys' insights.
Thanks
if I were asked the question, I'd take into account the current rate environment, so it helps to have a general knowledge of the yield curve. for example, if you showed me a corporate bond with a 12% YTM, 4% coupon and 10y til maturity, I'd assume something's wrong. reason being, your YTM is 3x the coupon in an environment where you're not seeing much better than 5-7 even in high yield. I'd assume that's a distressed issue, most likely an investment grade issue that's going through trouble.
there's something I learned in CFA curriculum, I forget the technical term but basically it's the weighted recovery you'd get if it goes through liquidation. yield to worst in my experience (which is limited in fixed) is more about call dates rather than liquidation.
perhaps @"Kenny_Powers_CFA" @"Martinghoul" or @"junkbondswap" could help, they're better than I am at this sort of thing.
The whole damn credit thang just ain't really my cup of tea, tbh...
Yield becomes less relevant as a bond becomes distressed. Yield assumes that, for a bond trading at a discount, you will clip the coupon as well as book the appreciation in the notes as the bonds accrete towards par at maturity. Given that there is a real possibility of bankruptcy in distressed credits, the aforementioned becomes less relevant. As such, the dollar price of bonds becomes more relevant as it represents a claim on the collateral. Generally, yields of 15%+ indicate distress. Dollar prices of sub-70s are indicative of distress.
YTW, generally the safest to get a sense of return. There are cases when YTC or YTP are relevant depending on the situation. Again, in the distressed space, dollar price is more relevant.
Thanks for your answer, really helpful. Can you please explain why dollar prices of sub-70s are indicative of distress? I'm not familiar.
For a distressed credit its more about price and very distressed/defaulting more of how much will you get back on your investment with which what price it trades at. Everyone else has hit on the YTW
Just a sense from the situations I have witnessed. Sub-70s tends to equate to a yield of 15% or above, generally speaking. In the current rate environment where spreads are tight and the number of bankruptcies are at all time lows, 15%+ is a tough rate of return to book without substantial risk to principal.
For question 1), you need to think about YTM as comprising two parts: a) the current yield; and b) the annual principal accrual. So if you have a 5-year, 5% coupon bond yielding 20%, the price is probably around $50. Essentially you are picking up 10% current yield and then another 10% in accrual ($50/5 years=10% per year). I don't know of a more precise way of doing it in your head but you should be able to ballpark it that way.
I agree that prices
The correct answer to the price question is that there is no definitive answer.
The key to answering is the theory. A credit security is distressed when the securities below it are a 0. When distressed, bonds tend not to trade on a yield basis anymore - instead they trade like equities.
Stressed bonds can be analyzed using YTM (not YTW, because the prepayment option favors the issuer, and the issuer cant afford to pay the call premium). Use YTM because you expect them to stay current on interest payments.
Distressed bonds are analyzed based on what you think recoveries will be. Make up any valuation methodology - but dont use yields.
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