Advanced Bond Analysis · Bonds Explained
Define a fictional security
Consider the fictional Harbour Utilities bond solely as a teaching case. It has $1,000 face value, a 5% annual coupon, three years remaining, no call option and a clean price of 98 on a coupon payment date. Ignore tax and transaction costs initially. It is senior unsecured debt in your spending currency.
The scheduled receipts are $50 after one year, $50 after two years and $1,050 after three years. The $980 purchase price is below par. Solving the present value equation gives a yield to maturity of approximately 5.74%. This assumes every payment is made on time.
Assess the borrower separately
Assume the fictional issuer has $800 million gross debt, $120 million unrestricted cash, $200 million EBITDA and $50 million annual interest expense. Net leverage is $680 million ÷ $200 million = 3.4 times. EBITDA interest coverage is 4 times.
These ratios do not establish safety. Suppose $180 million matures next year and expected cash generation after essential spending is $70 million. Cash plus that generation totals $190 million, leaving only $10 million after repayment before considering an operating buffer. Investigate liquidity facilities, restrictions and refinancing rather than accepting the headline yield.
Test what could go wrong
At a required annual yield of 7%, the scheduled payments have present value of about $947.51. Relative to a $980 purchase, that is a price decline of roughly 3.31%, before income or costs. This repricing assumes payments remain unchanged. A default scenario requires different cash flows and a recovery assumption.
Also test lower operating cash generation, a costly refinancing and the need to sell when buyers are scarce. Ask whether the investment would still meet its intended role in each case.
Write a conditional research note
A complete note identifies the security and timestamp, price and yield convention, repayment evidence, downside scenarios, liquidity and position constraints. It names unresolved questions and specifies the evidence that would change the conclusion.
For this case, the narrow cash buffer is a concrete research issue. The appropriate conclusion can be to request more information or decline the investment. Finishing a model does not create an obligation to buy. Apply the same process to a real security only after verifying its actual documents and current data.
Try it yourself
If the fictional issuer’s EBITDA falls to $160 million while net debt remains $680 million and interest remains $50 million, calculate net leverage and interest coverage.
Show the worked answer
Net leverage rises to 4.25 times and EBITDA interest coverage falls to 3.2 times. The next step is to reassess cash generation and liquidity, not to assume that the original valuation still describes the same risk.
Further reading
Educational material. Examples are hypothetical and do not recommend a security or a personal allocation. Contract terms and market conventions vary.
