悉尼大学固定收益证券课件Lecture 6.ppt

corporate debt and credit risk,lecture 6,dr. andrew ainsworth,finc3019 fixed income securities,two weeks ago.,binomial trees multiplicative random walk mean reverting selected models of the term structure what constitutes a good model properties of different models other uses of binomial trees effective duration revisited valuing a callable bond using a binomial tree,introduction,credit risk defaults recovery rate ratings agencies the information content of credit ratings structural models of default,discussion,the global financial crisis what caused the crisis? what were/are the consequences?,credit risk,credit risk,credit risk is the possibility of default by a counterparty in a financial transaction what constitutes default? credit events are costly,credit risk,how is a default resolved workouts new debt contracts debt service reductions liquidation reorganisations settlement formal bankruptcy proceedings (ch. 7 or ch.11 bankruptcy),costs of financial distress,lenders monitor the financial health frequently before maturity date covenants actions a borrower must undertake actions a borrower cannot undertake reorganisation boundary if a safety covenant is breached (value of the firm below threshold) six-monthly coupons allow debt holders to regularly monitor borrowers rather than waiting to maturity as is the case with the zero coupon bond this provides a credible signal direct and indirect costs of bankruptcy lenders and borrowers try and avoid these costs by renegotiating debt holidays rescheduling of interest and principal repayments,factors affecting default,macroeconomic recession reduces cash flow, liquidity and can lead to insolvency industry-specific competition stage of industry life-cycle e.g. bursting of dot-com bubble in the u.s. in 2000 firm-specific fraud poor management,recent examples,general motors ceo stated that gm would not make a scheduled $1b debt payment in april 2009 russia defaulted on its sovereign debt in 1998 enron fraud and accounting practices led to default in 2001 worldcom telco defaulted in 2002 due to accounting irregularities and fraud hih insurance placed into liquidation in 2001 due to mismanagement subordinated convertible noteholders received no distribution current issues in greece, dubai and other countries,source: chen (2008) “macroeconomic conditions and the puzzles of credit spreads and capital structure, working paper.,historical defaults,credit-rating agencies,credit-rating agencies,three major global ratings agencies moodys standard and poors fitch provide information on financial health of borrowers and their debt instruments (companies, governments, etc) borrowers generally pay to have their company and debt rated ratings agencies do not provide a real-time evaluation of borrowers borrowers are evaluated at intermittent frequencies a companies share price can provide some indication of financial health,credit-rating categories,debt can be investment grade or non-investment grade investment grade higher quality restrictions in investment mandates non-investment grade (speculative or junk) lower quality credit ratings affect the cost of borrowing in fixed income markets,credit-rating categories,what factors determine credit-ratings?,moodys aims to determine the predictability of future cash flows factors that they consider: industry trends sensitivity to the business cycle competition: local and global barriers to entry political and regulatory environment management quality and strategy diversification of business lines financial position and sources of liquidity rating of debt instruments also considers covenants collateral,example: ratings factors for airlines,s&p focuses on business risk and financial risk selected factors that s&p considers when rating airlines share of industry traffic membership in global alliance geographic position of airlines hubs competition at airline hubs capacity utilisation pricing (passenger revenue per available seat mile) non-passenger revenue ranking in customer satisfaction operating costs per available seat mile fuel price hedging aircraft fleet (number, type, fuel efficiency, etc),default rates by credit rating category (1971-2006),ratings migration,ratings migration is the probability of moving from one rating category to another this information is important for investors average one-year migration rates from 1970-2009,recovery rates,in the event of default, debt holders typically recover a proportion of the face value: recovery rate the recovery rate is just as important as the default rate also of significance is the correlation between the default rate and the recovery rate altman, brady, resit and sironi (2005) “the link between default and recovery rates: theory, empirical evidence, and implications” journal of business, vol 78(6), pp. 2203-2227 altman et al (2005) examine corporate bond defaults from 1982 to 2002 and show that the default rate affects the recovery rate,recovery rates,factors affecting recovery rates,macroeconomic reduced value of asset sales in recession relative to a boom industry-wide recovery rate decreases if defaults are industry specific firm-specific recovery rates likely to be higher if default is caused by firm-specific causes other firms in industry still generating cash flow availability of collateral value of collateral under financial distress (fire sale) presence of multiple creditors,historical recovery rates,chen (2008),seniority and recovery rates,seniority of debt in capital structure level of protection offered by security expected recovery rate conditional on default can change debt of different seniority has different historical recovery rates secured bank loans: 71% senior secured bonds: 58% senior unsecured bonds: 46% senior subordinated bonds: 39% subordinated bonds: 36% jnr subordinated bonds: 28% all bonds: 41%,credit ratings and conflicts of interest,does a conflict of interest exist? ratings agencies are paid by issuers to rate their instruments ratings agencies have acknowledge this in the aftermath of the crisis state of connecticut is suing s&p and moodys over its ratings “rating agencies have found themselves in court before. when they were sued by enron investors for allegedly being too slow to downgrade the energy traders debt, a federal judge dismissed the claims, saying the ratings analysts deserved the same kinds of first amendment protections that shield journalists because their work was in essence opinion and not a guarantee.” ,superannuation fund sues s&p over bond rating,in australia, local government financial services (lgfs) is suing standard & poors and abn amro a debt instrument was initially rated aaa by s&p, but 12 months after the lgfs investment the instrument was rated bbb lgfs has alleged that standard & poors breached the corporations act by giving the debt a aa rating which implied that the instrument was very secure and had a low probability of default lgfs has claimed s&p was negligent, disregarded or inadequately considered the credit risk, and that its financial modelling was not sufficiently rigorous. .au/business/super-investor-sues-sampp-over-bond-rating-20100308-pstp.html,credit spreads,the difference between the yield on a corporate debt security and a reference rate is termed the credit spread the spread is determined by the perceived credit risk associated with the issuer it also includes idiosyncratic risk and other debt features such as embedded options the reference rate is usually a short-term government interest rate or a swap rate we can examine the credit spread to obtain some idea about the credit risk embedded in securities of different ratings,credit spreads,the information content of credit ratings,creighton, gower and richards (2007) “the impact of rating changes in australian financial markets”, pacific-basin finance journal, vol.15 pp.1-17 motivation performance of ratings agencies has been questioned after collapse of enron and worldcom prior literature finds that ratings changes do not contain new market sensitive information research question how do corporate debt and equity prices react to changes in credit ratings in australia?,data,standard & poors and moodys ratings between jan 1993 and june 2003 exclude ratings announcements that coincide with firm-specific news announcements include both actual rating changes and watch events bond prices from ubs and merrill lynch debt sample 33 announcements: 21 negative and 12 positive equity sample 141 announcements: 95 negative and 46 positive sample includes a broad cross-section of australian stocks 62 firms 15 industries,event study approach equities: use market model to estimate expected returns in estimation window abnormal returns are the deviation between actual returns in the event window and expected returns bonds: analyse the impact on spreads over cgb of comparable maturity,method,results,fig 1: cumulative change in bond spreads,results,results,cumulative abnormal equity returns in estimation window,results,cumulative abnormal equity returns in event window,results,conclusion,changes in ratings affect bond yields can be interpreted as news spread reactions are in the hypothesised direction spreads increase with negative news and decrease with positive news the same conclusion cannot be made for equity returns equity prices decline prior to ratings change,structural models of default,structural models of default,structural models of default originated with merton (1974) and black and scholes (1973) work on options pricing these models view equityholders (the owners of the firm) as having a put option on the firm that can be exercised when the value of the firm falls below a certain level when they exercise the option they in effect give the assets of the firm to the debtholders debtholders are short a put option they can hand over the assets to debtholders because shareholders have limited liability let us consider a simple case where the firm has only zero coupon debt and we will ignore any costs of financial distress,structural models of default,structural models of default,face value of debt equals the strike price on the option if the assets fall below the present value of the debt then equityholders can walk away and default on their obligations risky loan = risk-free loan put value to default risk-free loan risky loan = put option,structural models of default,assuming default is costless, we know that: value of firm (v) = value of equity (s) + value of debt (d) at maturity of the zero coupon bond, debtholders receive: minf,vt = f max0,f vt the payoff to equityholders is a call option: max0,vt f black and scholes (1973) show that the value of equity (s) is: where v is the value of the firm, f is the face value of debt, r is a risk free interest rate, t-t is time to maturity and n(d1) and n(d2) are probabilities from the normal distribution,structural models of default,we can determine the value of debt by substituting into the firm value identity: the value of debt