Leveraged Finance: Concepts, Methods, and Trading of High-Yield Bonds, Loans, and Derivatives

CHAPTER 1

Introduction

In the credit market, banks, and brokers raise debt capital for corpo■ rate entities that need funds for a variety of reasons such as working capital needs, merger and acquisition activities, share buybacks, and capital expenditures. Capital can be raised via various debt instruments, but primarily through bonds and loans.

One segment of the overall credit market, the leveraged finance market, is comprised of market participants (i.e., issuers and investors) with somewhat unique needs. With regard to issuers, these unique needs result from the fact that they have, or desire to have, a proportionally large amount of debt relative to a “normal” corporate capital structure. An issuer in the leveraged finance market is usually considered more risky than a company with a more balanced capital structure and, as a result, has a relatively low credit rating. Issuers in the leveraged finance market are companies that issue debt and have a credit rating below investment-grade (below BBB-/Baa3).

Of course, investors in the leveraged finance market expect that with more risk comes more return potential. Investors range from hedge funds to insurance companies, but the one common thread shared by all leveraged finance investors is that they all have relatively high return objectives. In the past, the assets within the leveraged finance market fell into one of two categories: cash bonds or cash loans. But this has changed. With the introduction of products such as credit ...