FIN 614: Financial Management
Larry Schrenk, Instructor
1. Term Structure of Interest Rates
2. Junk Bonds
3. Bankruptcy
Term Structure of Interest Rates
Yield Curve
Long Term vs. Short Term
Treasury Securities (Usually)
7.00
6.80
6.60
6.40
6.20
6.00
5.80
5.60
5.40
5.20
19
99
20
01
20
03
20
05
20
07
20
09
20
11
20
13
20
15
20
17
20
19
20
21
20
23
20
25
Interest Rates
Yield Curve
(11 September 1997)
Maturity
NOTE:
Annual Returns on Bonds (not HPR) versus
Maturities (not Time)
Yield Curve Shapes:
Upward  Normal Yield Curve
Downward  ‘Inverted’ Yield Curve
Yield Curve Shape Theories:
Pure Expectations Hypothesis
Premia: Liquidity (LP), Maturity (MRP), Default
(DRP)
Yield Curve Shape a Function of Future
Interest Rates
Expected Inflation
Increase Expected  LT > ST
LT Rates Average of ST Rates
Implied Future Rates
What are Junk Bonds?
‘High Yield’ Bonds
Versus ‘Fallen Angels’
Compare with IPO’s
Michael Milken and Drexel Burnham
Lambert
Leveraged Buyouts
Agencies
Standard & Poor's
Moody's
Fitch Ratings
Distinction
Investment Grade Bonds
Junk Bonds
Standard & Poor's System
Investment Grade
AAA: the best quality companies, reliable and stable
AA: quality companies, a bit higher risk than AAA
A: economic situation can affect finance
BBB: medium class companies, which are satisfactory at the
moment
Non-Investment Grade
BB: more prone to changes in the economy
B: financial situation varies noticeably
CCC: currently vulnerable and dependent on favorable economic
conditions to meet its commitments
CC: highly vulnerable, very speculative bonds
C: highly vulnerable, perhaps in bankruptcy or in arrears but still
continuing to pay out on obligations
CI: past due on interest
R: under regulatory supervision due to its financial situation
SD: has selectively defaulted on some obligations
D: has defaulted on obligations and S&P believes that it will
generally default on most or all obligations
NR: not rated
Bankruptcy
Cannot Pay Creditors
Formal Legal Proceeding
Transfer of Ownership
Financial Distress
Direct Costs
Legal and Administrative Costs
Indirect Costs
Impaired Ability to Conduct Business
Agency Costs
Liquidation
Chapter 7 (Federal Bankruptcy Reform Act of
1978)
Assets Sold, Proceedings Distributed
Absolute Priority Rule (APR)
‘Strategic’ Bankruptcy
Reorganization
Chapter 11 (Federal Bankruptcy Reform Act
of 1978)
Restructuring with provision to repay creditors
FIN 614: Financial Management
Larry Schrenk, Instructor