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Strategies & Market Trends : Waiting for the big Kahuna
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To: James F. Hopkins who wrote (28331)9/18/1998 3:02:00 PM
From: Oeconomicus  Read Replies (1) of 94695
 
Jim, I must take issue with your argument about lower rates and the calling of debt. Corporate debt that is callable is not that common, especially in the junk arena (and any that is would be price on a yield to call basis, not to maturity, so a rise in rates would not result in much appreciation in prices). Investors in junk debt do not want to take the higher risks only to give up the upside of an improvement in either credit of the borrower or of generally lower interest rates. Prepayment provisions generally only allow prepayments based on discounting the remaining P&I payments back to the present using comparable term treasury rates, either flat or with a very small spread. With this kind of "make whole" provision, the current environment of falling treasury rates, but rising or flat junk rates actually makes it more costly to prepay junk debt.

Also, cuts in rates do not necessarily "make more capital available". The widening of spreads over treasuries is an indication of a lack of appetite for risky (relative to treasuries) debt abound bond investors and banks. This would indicate either a lack of liquidity or a tightening of credit standards (or both) and is an indicator of economic slowdown or recession.

Regards,
Bob

PS: Convertible corporate debt is frequently callable, but that is simply a means of forcing conversion to stop the interest accruals and reduce balance sheet leverage when the conversion value exceeds the call price.
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