Saturday, September 25, 2010

A Primer on Corporate Bonds – II (Credit Risk): Million Dollar Journey

A Primer on Corporate Bonds – II (Credit Risk): Million Dollar Journey

Posted: 15 Sep 2010 04:30 AM PDT
This is a column by regular contributor Clark.
Credit rating agencies such as those mentioned in Part I of the series consider several parameters before issuing their ratings. But, an astute investor may want to look at a few metrics on his own to assess credit risk and boost his knowledge at the same time.

Credit Risk Analysis – Interest Coverage Ratio

Interest coverage ratio refers to the number of times a corporation would be able to make the annual interest payments on its debt based on current annual earnings before interest and taxes (EBIT), i.e.,
Interest Coverage Ratio = Earnings before Interest and Taxes (EBIT) / Annual Interest Payments
From an investor's perspective, the interest coverage ratio should be as high as possible. A low interest coverage ratio indicates that the company has high debt (or earnings not living up to leveraged expectations), which could translate to potential bankruptcy or default. Ideally, the company should have enough earnings to cover its debt payments, i.e., the ratio should at least exceed 1.0.
It is worth noting that though interest coverage ratio is calculated as above, it is questionable whether earnings before taxes should be used. After all, it is known that all corporations pay taxes. So, if a certain amount is going to go to taxes, then we are left with a skewed metric. The ratio may have looked good when using EBIT but in reality, could be distorted. So, a conservative investor may want to use earnings before interest payments (and not EBIT) to compute interest coverage ratio and get a better picture.

Credit Risk Analysis – Capitalization Ratio

Capitalization ratio is a measure of the long-term debt of a corporation to its total capital (assets). Total assets include long-term debt and shareholder's equity.
Capitalization Ratio = Long-term Debt / (Long-term Debt + Shareholder's Equity)
This metric evaluates the amount of debt that the company carries in relation to its total capital, i.e., financial leverage. A ratio of 1.0 would show that there is no shareholder equity in the company and the entire assets are based on debt. Such a business may not be a good candidate for the bond investor. Hence, the capitalization ratio should be as low as possible and definitely less than 1.0 to indicate that there is at least some shareholder's equity in the business.

Credit Spread

As you would have realized, corporate bonds carry additional risks when compared to government bonds. Companies compensate the investor who bears these extra risks by offering a better yield than government bonds. The difference between the corporate bond yield and government bond yield is known as credit or yield spread.
Credit spread or yield spread = Corporate bond yield – Government bond yield.
The return for accepting additional risk should show in the spread. The higher the credit and/or call risk (will be addressed in another article) of a bond, the greater the credit spread.

Company Factor

Let us assume that a bond investor has done his due diligence by checking credit ratings and analyzing various risks to buy an individual corporate bond. What would happen to the bond due to market or specific company changes? For example, if the financial leverage of the company gets minimized over time, then the credit rating agencies may upgrade the credit rating. This would indicate that the risk of default is reduced, pushing the corporate bond toward government bonds on the "risk of default" scale and, in turn, reducing the credit spread.

Market Factor

If the interest rates go down, then the bondholder stands to gain, since the yield of newly issued bonds would be lower. The bondholder would have a bond that offers a higher yield than the new bonds and hence, the price of his bond will go up to reflect the higher worth. As would be evident, an increase in interest rates would leave the bond investor holding a bond that is worth less (through lower yield and dropping price) than the new issues.
In the next part of the series, we'll look at the other risks involved in buying corporate bonds.
About the Author: Clark is a twenty-something Saskatchewan resident employed in the manufacturing sector. He repaid around $20,000 in student loans and has been working to build his investment portfolio as a DIY investor (not trader) while nurturing plans to retire early. He loves reading (and using the lessons learned) about personal finance, technology and minimalism.
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Normal is Broke

Living With A Chain

How to Get a Job when No One is Hiring

When the jobs are hidden

To get a job, you have to find the openings that no one's advertising, and really impress your potential employer.

By Jia Lynn Yang, writer-reporter

NEW YORK (Fortune) -- David Perry, a longtime headhunter, says you're wasting your time if you're looking for job postings online. And he should know: he's often the guy on the other side helping companies lure new talent. Perry, who's based in Ottawa, says that in the last 22 years he has accomplished 996 searches totaling $172 million in salary. And the bottom line in today's economy, he says, is you have to tap the "hidden job market."

Perry's also the co-author of "Guerrilla Marketing for Job Hunters" and he recently spoke with Fortune.

What's the "hidden job market"?

When companies say, 'We have a hiring freeze,' that doesn't mean they're not hiring. It just means they're not adding headcount. Every year there's 20-25% turn over. So in a 1,000-person company, 200 or 250 people are going to turn over, either through attrition, or someone moves. Those companies are still hiring but they don't want to tell you.

So how do you find these jobs?

What you have to do in a recession is map your skills to employers to where you know they have a problem you can solve. My advice to job hunters is pick 10 to 20 companies, no more, and pick companies you're interested in, and that you think you can add value to. That requires researching companies, and so that list may take you two weeks. If you're trying to crack the hidden job market and you know the job position you want reports to vice president, find that vice president on LinkedIn and look at his profile to see who else he's connected to and go ask them, 'What's this guy like to work for?' Do the research before you even pick up the phone.

How can you get someone's attention?

We can go into billboards, sandwiches - that stuff only works once. It's only for one person who figures it out once, once in a city. If you're looking for fun stuff, we have this thing called the coffee cup caper, 30% of the time it will result in an interview. You send an employer a coffee cup with a little $5 swipe card with a little note that says, I'd like to get together and talk with you over coffee. I'll be calling soon. And you send it by U.S. post two day delivery, and that gets registered. So when they've signed for it, you wait about 20 minutes and then you call them. And then you go, Hi, I know you just got my package.' You're proving you're imaginative and creative.

What something people should avoid during a job interview?

This drives me insane: I've seen people mentally deciding in the interview whether they want the job. That's the last place to decide. You go into an interview, and you sell like your life depends on it. You've got to get the job first. I've seen it thousands of times. There's this point in the interview, where people go 'Hmm, do I really want this? You can see their body change. The employer picks it up and it's gone. If the employer is telling you, 'I love you,' and you're not saying 'I love you too,' it's over with.

How about following up afterwards?

If you really like the opportunity, don't go home and write thank you very much. Go back and write a letter that says, upon further reflection of what we were talking about, here's what I bring to the table, here's how I see myself fitting into the organization, including a 30-60-90 day plan.

How can someone attract a recruiter's attention?

You have to go to ZoomInfo and LinkedIn and create a profile. All corporate recruiters and probably 20% of the headhunters in America have ZoomInfo accounts. When we start a search, companies aren't going to advertise. The headhunter goes to ZoomInfo, types in requirements that we need, like skillset, degree, city, functional title, and up will come anywhere from a hundred to several thousand people who fit that criteria. Then we go to LinkedIn and run the same search. If you're in ZoomInfo with a picture, we're going to call you first. Just reverse engineer what recruiters are doing so you get found.

How can you really impress a potential employer?

It hasn't worked in years just to bring in your resume, except only in the most junior positions. I concentrate on directors to CEOs, and the last interview for us regardless is always a Power Point presentation of what you've learned, pain points, and how you intend to fix that. Everyone talks about being a great leader and great communicator, so prove it. Don't go into an interview and treat it like it's just another business meeting. Your career is your biggest asset now - because it's certainly not your house. To top of page


August 2008 Dave Ramsey on Barack Obama

This was aired in August 2008. So was Dave right???