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- Topic: Fixed Income question level 1
| Author | Topic: Fixed Income question level 1 |
|---|---|
| arendb @2014-05-15 18:57:02 |
Hi Quick two questions: 1) What is considered a cheaper form of financing? Debt or equity? 2) From an issuer point of view, what would generally be cheaper? zero-coupon bonds or coupon bonds? Looking forward to read about your views. Cheers |
| teje @2014-05-16 07:13:41 |
debt is cheaper due to interest tax shield...company usually issues more debt than equity to reduce the firm's WACC. However, too much debt will increase the cost of equity (as equity holders are more at risk now, due to the higher interest payments, possibly leading to default. Shareholders thus demand higher return on equity). As a result the firm's WACC will actually increase with each new issue of debt as oppose to decreasing. There is essentially an optimal level of debt/equity ratio that can be determined, creating the lowest WACC. |
| paulhugan2k @2014-05-17 12:23:20 |
2) From an issuer point of view, what would generally be cheaper? zero-coupon bonds or coupon bonds? For an issuer, Zero Coupon bonds will be cheaper. If we compare Zero Coupon and Coupon bonds with same price and par value, YTM of Zero Coupon bond will be lower than YTM of coupon bond. Lower YTM means less cost of debt financing for the issuer. Since point of view of WACC, the lower YTM will lower the WACC and will increase firm value. |
