CORPORATE VALUATION SERVICES
DEBT SECURITIES
On the surface, the consideration of the valuation of debt securities seems to be a straightforward exercise in present value analysis. However, capital markets participants have developed a wide variety of options, features and structures of debt and debt like instruments. These include, but are not limited to, the following:
- Domestic versus Eurobonds.
- Coupons versus zero coupon.
- Secured versus floating rate.
- Fixed versus floating rate.
- Senior versus junior.
- Callable versus extendable versus retractable.
- With or without warrants.
Businesses also extensively use lease financing as a substitute for secured debt financing, which might or might not result in a capitalized liability on the balance sheet (capital leases versus operating leases).
Debt securities are valued by determining the present value of future payments, discounted back to the current time at an appropriate discount rate. If a security is bought and sold in the public markets, the observed market value determines the present value of the future payments. If a debt security cannot be bought and sold in a public market (a closely-held debt security), its value must be estimated using the discounted present value formula. The three primary elements that must be determined are the following:
- The amount of future payments generated by the debt security.
- The timing of the future payments.
- The appropriate rate of interest or yield to maturity to apply to the future payments.
The amount and timing of future payments is generally determined by the contractual obligations contained in the debt instrument, while the appropriate rate of interest requires quantitative analysis and judgment. Estimating the appropriate yield to maturity typically includes a search for and analysis of guideline public debt securities, with comparability adjustments made to those guideline indicated interest rates. This process is similar to the application of the guideline company method within the market approach when valuing a business or business interest. The presence or absence of ready marketability is also a factor that must be considered, but lack of marketability discounts on debt securities are typically lower than that required for privately held equity securities.