Interview Question on bonds

Denic's picture
Rank: Senior Chimp | 18

I am preparing for an interview in Debt Capital Market. I went on the forums and different websites collecting potential questions.

I found this question:
Say you have two high yield bonds with identical coupons and maturities, one from a supermarket and one from a high tech company. Which one do you buy and why?

Here is how I would tackle this question:

The high tech company will represent a higher risk in terms of paying the coupons and the principal. Regarding the cash flow it generates and the liquidation value of the company.
- More uncertainty regarding the cash flow during the "life" of the company versus the supermarket company (annual sales of the products in the stores).
- Liquidation value difficult to estimate: lots of intangible assets (patterns...) versus the supermarket (stores to sell in case of bankruptcy, products in stock to sell).

But, we can also say that in a "perfect market", this higher risk must be reflected in a lower bond's price (when buying it in the secondary market) compared to the supermarket's bond price.

So, everything will depend on the risk appetite of the investor. If I am a risk-adverse investor, I would choose the supermarket company because there is a higher probability that the company will be able to pay the coupons and pay back the principal. But, if I am more a risk-taker, I may choose the high tech company.

What do you think of this answer.....
Thanks a lot.

Comments (25)

Feb 9, 2015

I think your answer is spot on. I would like to hear what other people have to say. I worked in DCM over the summer and found this to be very helpful in preparing for my interview if you have not looked at it yet.

http://www.leveragedloan.com/primer/

Good luck, I think you will do fine.

Feb 9, 2015

I think that makes sense you may also want to know the call features of both of the bonds as well as look at the liquidity in the secondary. Also if there is any talk of future debt issuance which would lower coverage ratios

Feb 9, 2015

You should've asked clarifying questions.

I'd rather buy bonds from Microsoft than Safeway, for example.

Most grocery stores have 0 assets (stores leased and large portion of inventory is perishable)

But your answer was fine. B or B-

Feb 10, 2015

Thanks for your inputs for all of you

Jun 25, 2015

Hey,
I know I'm super late to this thread by a few months but I want to add a point you guys might have missed.
The biggest difference (and, personally, the first that should come to mind) is "What collateral is there?"
In a generic case, non-tech companies have very few, if any, hard assets and most of their cash flow is I.P.-related. Contrast that to a grocery store chain where (lets assume they own all the operating assets) the store, distribution centers, food delivery trucks, equipment, etc. can be used as collateral.
The presence of collateral substantially reduces credit risk in a stark contrast between both industries.
A great place to start is to look at the balance sheet to see if they even have assets in place.

I know we are talking about a high-yield scenario but even in this case, you should still assess collateral and where you stand on the capital structure.
You guys got the stable cash flow point so I didn't mention that.

    • 1
Jun 25, 2015
reed.maybee:

Hey,
I know I'm super late to this thread by a few months but I want to add a point you guys might have missed.
The biggest difference (and, personally, the first that should come to mind) is "What collateral is there?"
In a generic case, non-tech companies have very few, if any, hard assets and most of their cash flow is I.P.-related. Contrast that to a grocery store chain where (lets assume they own all the operating assets) the store, distribution centers, food delivery trucks, equipment, etc. can be used as collateral.
The presence of collateral substantially reduces credit risk in a stark contrast between both industries.
A great place to start is to look at the balance sheet to see if they even have assets in place.

I know we are talking about a high-yield scenario but even in this case, you should still assess collateral and where you stand on the capital structure.
You guys got the stable cash flow point so I didn't mention that.

Jun 25, 2015

Explain convexity as it relates to term structure of interest rates.

"He that hath a beard is more than a youth, and he that hath no beard is less than a man." -- William Shakespeare, Much Ado About Nothing

Jun 25, 2015
Silent Guardian:

Explain convexity as it relates to term structure of interest rates.

No one in distressed thinks like that. Go back to investment grade.

Jun 25, 2015
Silent Guardian:

Explain convexity as it relates to term structure of interest rates.

Can someone ban this idiot already? It's bad enough that he posts unfunny troll threads but fucking stupid answers to serious questions like this greatly diminishes the quality of this site.

    • 1
Jun 25, 2015

Reg S vs. 144A and fungibility. Some grace period questions etc..

Just remember that it's a much less liquid market. Explorer how you would build positions for clients etc.

It wouldn't do you harm to look into CDS, there's a very interesting sit. in Europe at the moment with Codere, paying its interest after the grace period, causing and Event of Default which technically should trigger the CDS, but it shouldn't if you step out of contract land. So there's going to be a fight.

If you're US side, best to familiarise yourself with Capt 11. Also, market trends, holders etc.

Jun 25, 2015

Thanks Oreos, really appreciate the advice. Reading up on Codere as you suggested.

I should have stated in my original post this is a buy side role. So not building positions for clients, but in this case for the firm. But I'd guess your point still holds about the lack of liquidity and difficulty/time needed to build positions...

thx again for your comments

Jun 25, 2015

your answer is: 105/(1+.20)^1 = $87.50 providing that you purchased it at par value.

Jun 25, 2015

I highly recommend that you invest in a TI 89 Titanium or some other sort of calculator that has financial functions, if you don't already.

n=1
i=20
pv=???>>>>>>>>>>$ 87.50
pmt=5
fv=100

Jun 25, 2015
Jun 25, 2015

The 2020's are trading at 15.5 yield.

Jun 25, 2015

is equal to 2120

"Make 'Nanas, not war! "

Jun 25, 2015
Comment

When you assume, you make an ass out of you... and only you.

Jun 25, 2015