Leveraged finance relates to funding a business, a company or another investment using more debt than would be considered normal. More than normal debt is going to imply by nature that the funding is a riskier prospect, and therefore more costly than normal borrowing in general. As a result, leveraged finance options are most commonly employed in order to achieve a specific objective that is often temporary by nature. For example, the specific objective may be to make an acquisition, to effect a particular buy-out, to repurchase some shares, or to fund a dividend. Although different banks offer different options when it comes to leveraged finance, and there are generally two different main products to concern yourself with. These products are leveraged loans and high yield bonds.
Leveraged loans, which are often regarded as credits that are priced 150 basis points or more over the offered rate, are essentially loans that offer a high rate of interest in order to reflect the higher risk that is posed by the borrower to the lender. High yield bonds or junk bonds are those that are rated below what is known as investment grade. One key instrument in much of the world of leveraged finance, especially when it comes to leveraged buyouts, is mezzanine, which is known as "in between" debt. Mezzanine debt has been used for a long time by mid cap companies, especially in the United States and in Europe. These in between forms of debt are used to be a funding alternative to bank debt or high yield bonds. They rank between senior bank debt and equity when it comes to a capital structure within a company, and higher risks may be taken but these higher risks are rewarded much better as well, with returns averaging between 10 and 20 percent or more.
Leveraged finance, just like with other parts of structured finance, generally involves identification, analysis and solving of risks above all else. These risks can be arranged into a number of different groups depending on what they are and how risky they are. Credit risks, for example, are risks that are concerned with the business and its particular market. These are financial risks that lie as a whole within the economy, such as interest rates, tax rates and foreign exchange rates for example. Structural risks on the other hand are risks that were created by actual financial provisions, including settlement risks, documentation risks and legal risks. Finally, liquidity risks are risks that are associated specifically with a leveraged company's inability to refinance itself because of credit conditions that are too tight.
Leveraged finance is a risky business, and therefore it is not for everyone. If you have the necessary capital to invest in high risk and high return investments, then leveraging may be worthwhile as an investment consideration. If you do not have the capital or the willingness to take risks, however, then leveraging may not be the best way to go.
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Originally posted 2009-01-05 05:08:44. Republished by Blog Post Promoter
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