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.