Every concept, endless questions
Each concept is a small financial model. Read how it works, then draw a real interview question from it: forwards, backwards or what-if, with fresh numbers and a worked solution every time.
Forward runs a concept the usual way. Inverse runs it backwards, which is what separates understanding from memorizing.
Credit
5 conceptsYield to maturity and yield to worst
A bond’s coupon is what it pays; its yield is what you earn, and the two differ whenever the price is not par. Yield to maturity is the single rate that discounts every coupon and the principal back to the price you pay. If the bond can be called early, the issuer will call it when that is cheaper for them — which is exactly when it is worse for you — so a callable bond trading above par should be valued to the call, not to maturity. Yield to worst takes the lower of the two, and it is the number a credit desk quotes, because it is the return you can actually count on.
Recovery analysis
When a company cannot pay, what each creditor gets depends on two things: what the business is worth in distress, and where the creditor stands in the queue. Value flows down the capital structure in strict order — secured lenders are paid in full before the unsecured see a cent, and the unsecured are paid before equity — so the same enterprise value can mean a full recovery for one class and pennies for the next. A distressed investor’s work is to estimate that value, find the class where it runs out, and compare what the bonds will recover with what they cost today.
Credit spread decomposition
A bond’s spread over the risk-free rate is compensation for two things. The first is the loss you should expect: the chance the issuer defaults in a year, times what you lose when it does. The second is everything else — being paid to bear the uncertainty, to hold something illiquid, to take the risk that the defaults cluster. Split the spread and you can see how much of it is a fair price for the losses and how much is a premium. Run it backwards and you get the default rate the market is pricing in, which is the number to argue with.
Loan to own and the fulcrum security
In a restructuring, value runs down the capital structure until it runs out. The class where it runs out — paid partly but not fully — is the fulcrum. Everyone above is made whole; everyone below is wiped out; the fulcrum gets the company. That makes it the most interesting security in the structure: buy enough of it at a distressed price and you are not buying a bond, you are buying the reorganised equity at a discount, with a seat at the table when the plan is written. Loan to own is the strategy of finding the fulcrum before the market does and paying bond prices for equity.
Covenant breach: what it takes and what the lender gets
A maintenance covenant is a tripwire the lender sets so that it gets to the table before the money is gone. Two wires are common: leverage must not rise above a ceiling, and interest coverage must not fall below a floor. Both are ratios of EBITDA, so both are tests of how far EBITDA can fall — and one of them is always closer than the other. When the wire trips, the borrower has three ways out: a sponsor writes a check to cure it, the lender waives it for a fee and a higher coupon, or the loan is renegotiated. For a credit investor the covenant is not the risk; it is the moment the risk gets priced.