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FI (Credit risk & analysis, FI Features, (Bond issuers)) - Coggle…
FI
Credit risk & analysis
Top-down: Start from macro
Country: Legal & political system
Currency: Exchange rate fluctuation
Condition: Econ environment
Bottom-Up: Start from firm
Collateral: Quality & value of asset
Character: Willingness to repay debt
Capacity: Ability to make payment
Calculation
Recovery rate = 1- Loss Severity
Loss given default LGD = EAD * (1 - Recovery rate)
Exposure at default EAD = Principal + AI - MV of collateral
Expected loss EL = LGD * Probability of Default
G-spread = YTM of risky bond - YTM of rf bond
G-spread > EL = Investors are well-compensated
Credit rating
Measure of probability of default
Lag market --> So trading on credit rating change may underperform market
IG Grade: Above BBB- or Baa3 (Moody's)
HY rating: Below BB+ or Ba1 (Moody's)
FI Features
Bond types
From coupon
Variable interest debt
Step-up bond = Lower coupon (earlier) + Higher coupon (later)
FRN = MRR (Market Reference Rate) + Credit Spread (eg 50bps)
CLNs (coupon linked to credit rating)
Green bond with step-up event: Higher coupon if ESG goal not met
Index-linked Bonds (eg TIPS): Gov issued bond that is inflation-protected
Zero-coupon
Fixed coupon
Contingency bonds: Options-embedded
Putable: For YTM > Current Rates
Investor can ask for money back earlier
Higher price = Benefit bondholder
Price Straight Bond + Puts
Convertible
Investor can convert FI into common equity
Price = Straight bond + Call on equity
Conversion ratio CR = Par / CP Conversion Price
Conversion value = Share spot price * CR
Share spot Price > CP
Option = ITM = Bondholder should convert
Convertible bond behave like equity, not FI
Callable: For YTM < Current Rates
Called back by issuer/paid earlier to buyback bond
Lower BP = Issuer benefit
Price = Straight Bond - Calls
Warrants
Detachable options
Can trade warrants separate from bond (unlike convertible bond)
Investor pay more for Warrant + Bond --> So Warrant = Higher yield
COCOs (Contingent Convertibles)
Convert AUTOMATICALLY if event is triggered (eg capital ratio go over a level)
Help limit systemic default risk
From maturity
CM: >1yr
Perpetual
MM: <1yr
By what bond is backed by
Secured bond
Backed by firm's CF & collateral
Unsecured Bond
Backed by OCF only (as by high credit-quality issuer)
FI Contract
Indentures
Legal Contract between lender & borrower
Convenents: Terms & Conditions in Indentures
Affirmative Convenent
What issuer should be doing
Negative Convenant
What issuer should not be doing
CF Structure types
Bullet Bond ie normal bond
Fully-Amortizing Loan
CF as periodic loan payments (fully pay off loan by maturity)
Sinking Fund Provision
Issuer redeems some portion of outstanding issue per yr
Distribution Waterfall (for ABS)
Bond made of diff tranches
Upper tranche repaid first, then lower
Bond issuers
IG Issuer
YTM only depends on gov yield
High credit quality --> So credit spread close to 0
Up to 30yr maturity
Few to 0 restrictive convenent + can be unsecured
Use financial ratio + credit rating to evaluate performance
HY Issuer
Up to 10yr maturity
YTM depends on Credit Spread
CF more uncertain --> Have equity-like performance
Many restrictive convenant
Use Prob. of Default + LGD for performance
Corporate issuer
Financial firms: Focus on repos (repurchase agreement)
Steps
Borrower give bond to lender; Lender give money to borrower
This exchange is continuous/ repeatedly
If fail to repay, lender keep bond
Calculation
Repo Haircut
Repurchase Price
Purchase Price
Variation Margin
Help finance asset purchase + Earn short-term income
Default risk + Collateral risk + Margining risk
Non-financial firms
More reliable: Committed Facility
Need upfront fee
Most reliable: Revolver
Bondholders protected by convenants
Least reliable: Uncommitted Facility
No upfront fee