Have you ever read through the business news and come across an article that trumpeted the upgrade of a company's corporate bond ratings from B+ to BB-? Come on now - what the heck does that mean and why on earth should anybody care about it?!
As it turns out, it is a big deal. What it means is that particular company's cost of borrowing money has just dropped - maybe substantially depending on how high it's new rating is. It also means that the company is going to be able to take the same money its making today and deliver more of it to its bottom line. Conversely, when a company's bond ratings are downgraded, it means that its cost of new borrowing has just increased, making it less able to deliver the kind of bottom line results it might have been able to do previously.
In either case, if you are an investor with holdings in the company or potentially looking at investing in the company, that's vital information that can affect your decision to buy, hold or sell your holdings.
That's why Political Calculations has decided to create the following tool, which you may use to guesstimate the relative cost of a company's credit. We call it "guesstimating" because it's not easy to come up with a company's total debt picture. You have to do some serious data mining going through the Moody's or Standard & Poor's debt rating services and even the footnotes in a company's annual report to get the details of how the company's top management team has structured its debt.
So, instead of going to all this trouble, we figured it would be easier to look at the relative spreads of composite corporate bond ratings in the recent past (30 June 2004), and assume that today's composite bond market comes close to looking something like it.
So that's how we created the tool below - we took the spreads for the composite corporate 30 year bond ratings linked above, created a polynomial expression that represents the historic data fairly well, then tied it to the easily obtainable current 20 year AAA corporate bond yield from Yahoo! Finance. Just enter the indicated information in the table below, and the tool will guesstimate the rest....
So, using the default values, that company that was upgraded from B+ (9.16%) to BB- (7.96%) really has the potential to save 1.20% on its debt. Compounded over 20 years, we're talking some serious money! Compare this change to the very small change a top ranked company would see if their bond rating increased from AA+ to AAA - given the magnitude of the positive change involved, investors of the lower rated company should expect to see a significantly higher jump in the price of its stock on the news.
In any case, please remember that the rates estimated by this tool are only estimates at best - the corporate bond market is always in flux, which means there's little likelihood that this tool will accurately estimate the actual value of a given credit rating. The best it can do is guesstimate the relative value of a given credit rating compared to another one.
Labels: business, investing, tool
Welcome to the blogosphere's toolchest! Here, unlike other blogs dedicated to analyzing current events, we create easy-to-use, simple tools to do the math related to them so you can get in on the action too! If you would like to learn more about these tools, or if you would like to contribute ideas to develop for this blog, please e-mail us at:
ironman at politicalcalculations
Thanks in advance!
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