ACF Tutorial 3: Information asymmetry solutions (Financial distress costs + CDS)

  • Created by: charlie
  • Created on: 01-05-18 12:33
Debt enforcement contracts definition
In default debt holders guaranteed their claims (solves conflict of interest issue but imposes other issues...)
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Stricter debt enforcement contracts: Issues
1) Less investment in projects as SH want more div (under-investment theory) 2) Less asset growth as SH want more div (under-investment theory) 3) Riskier investments as SH want more div (risk-shifting theory)
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Imperfect debt enforcement: positives
SH Issues are mitigated (under-investment/ risk-shifting) but DH will require higher IR
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Other ways to solver conflict of interest issues (DH vs SH)
(Lecture 3): Covenants/ private debt/ ST debt/ security design/ project financing/ management compensation (act inline with SH + DH)
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Syndicate loan market definition
Loans offered by group of lenders, organised by a lead arranger
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Syndicate loan market: issue
Information asymmetry between lead arranger (originates loan) + participant of syndicate: 1) Adverse selection (screening good quality) 2) Moral hazard (monitor risk behaviour)
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Syndicate loan market: solution
'skin in the game': commitment device that incentivises lead arranger to screen for good quality borrower + monitor the riskiness of borrowers activities
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Syndicate loan market: CDS (+ve for lead arranger)
Buyer of bond (lead arranger) able to hedge against default of borrower (reduce credit risk)
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Syndicate loan market: CDS (-ve for syndicate participants)
Exacerbates information asymmetry issue causing: 1) Less loans of higher IR 2) reduced effectiveness of commitment device 3) increases borrowers default chance (speculators holding CDS push for riskier behaviour)
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Other cards in this set

Card 2

Front

Stricter debt enforcement contracts: Issues

Back

1) Less investment in projects as SH want more div (under-investment theory) 2) Less asset growth as SH want more div (under-investment theory) 3) Riskier investments as SH want more div (risk-shifting theory)

Card 3

Front

Imperfect debt enforcement: positives

Back

Preview of the front of card 3

Card 4

Front

Other ways to solver conflict of interest issues (DH vs SH)

Back

Preview of the front of card 4

Card 5

Front

Syndicate loan market definition

Back

Preview of the front of card 5
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