Debt – II

Subordinated debt ranks lower than other forms of debt (senior debt) in the event of liquidation but still ranks higher than equity.

Convertible debt allows bondholders to convert their debt holdings into equity shares at a predetermined conversion rate, often when the stock price rises.

Debt is generally cheaper than equity due to the tax-deductible nature of interest payments. As a result, increasing debt reduces WACC, provided the company does not increase its financial risk excessively.

The interest coverage ratio measures how many times a company can cover its interest expenses with its operating income. A ratio of 3.5 means the company earns 3.5 times more than its interest obligations, indicating strong coverage.

Callable bonds give the issuer the right to redeem the bonds before maturity, usually when interest rates decrease, allowing the company to refinance the debt at a lower cost. Callable bonds often come with higher interest rates to compensate bondholders for this risk.

Debt restructuring allows the company to renegotiate the terms of its debt to make it more manageable, often by extending the repayment period or lowering interest rates.

A downgrade in credit rating implies a higher risk of default. Lenders will demand a higher return to compensate for the increased risk, raising the company’s cost of debt.

When interest rates rise, the yield required by investors increases. Therefore, the price of existing bonds, which pay a lower coupon than the new higher rates, decreases to adjust for the difference.

As debt increases relative to equity, the company becomes more leveraged. If the company maintains the same profitability, ROE increases because equity is smaller while the returns are calculated on the same profit level.