Market value of debt
Can someone explain when you use it? For instance when calculating EV would use market or book value of debt? And why?
Also I wonder if I understood the concept correctly. According to this: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/valquestions/mktvalo…
I understand that market value of debt is effectively its present value (looks like annuity + discounted face value).
Am I right?
Looking at the link, while it's obviously a valid way to price debt, it still requires you to possess information that can only be roughly estimated (the cost of debt). You'd estimate cost of debt by looking at risk-free rates for an equivalent duration and adding a risk spread, but estimating the "correct" risk spread will be the tricky part.
If you want to know the value that the market is ascribing to the firm, then you would look at enterprise value ideally using market values of debt as well as equity / other claims on the firm. For CAPM, you are supposed to use the market value of debt and equity to estimate the capital structure weights in calculating WACC.
But honestly, I think that looking at MV of debt is generally not going to be useful in doing fundamental analysis. First, think about when the market price of debt is considerably different than the book value - outside of huge swings in interest rates, it's generally going to be a distressed situation, where the market is pricing in potential for default. If I am looking for a security to invest in within such a firm, I am (1) valuing the company, and (2) trying to find a security within the capital structure that is mispriced based on its claim on the assets. Say the cap structure is senior bonds, subordinated bonds, and then equity. The situation is as follows:
Value of Firm Operations + Any Excess Assets: I estimate at $800M.
Cap Structure Senior Bonds Face Value: $500M Price: 90; Market Value: $450M
Subordinated Bonds Face Value: $500M Price: 40; Market Value: $200M
Equity **
So let's say I am thinking of investing in the subordinated bonds. Do I want to think about the market price of the debt above me - the $450M - or the face value of the debt above me, $500M? If this goes to bankruptcy and the judge agrees that the value of the firm is $800M, then the senior bondholders could argue successfully for a full recovery of $500M, so it seems that the face value is the more relevant figure to use.
What about for the equity holder? Here it is particularly important to look at face value and not market value of debt. The market value of the debt is $650M, $150M less than my estimated firm value. However, there is $1000M of face value of debt that comes before the equity; this means that the debt holders will get paid any value up to their face value before the equity get anything. Here, the equity is worthless even though the market value of debt is well below the firm value.
So, that's a long-winded way of saying that I'd be careful about looking at market value of debt in certain situations. In distressed situations, the times where the market value is most likely to be significantly different than face value, weird things happen in the pricing of the different securities in the capital structure.
@"mk1275" This is amazing explanation. Honestly you should have a finance 101 blog. Thanks!!
Market value of debt is crucial when dealing with the implied EV of distressed companies. Otherwise you shoud ignore market value of debt and use face value.
Calculating Market Value of Debt (Originally Posted: 09/17/2014)
I am trying to get this figure for Nielsen. They have a few bond issues outstanding and I understand using the book value on the B/S is inaccurate.
How can I go about doing this?
Use trace data - you can see where the thing has been trading
I believe you can get there through Morningstar if you don't have access to a professional information system like bloomberg, facet, capIQ
People rarely do this but it makes a difference if debt is trading at a big premium or discount Really should mark to market for your multiple math / EV calculation
One way of doing this is to see if your company has any publicly traded debt and whether it has a rating. See what comparable debt issues are yielding and use this to discount the future value of your company debt back to the present. That will be the value that an investor, purchasing the debt at arms length would pay for the assignment of that debt
Some analysts use Book value as it could be very similar to market value. You can use a synthethic Rating scale to find out the spread over Rf, obtaining the Kd.
Once you get the Kd pre-tax, you can treat the debt as it all were a Bond.
wow, way to overcomplicated things chaps.
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