BUSF_A01.qxd

Chapter 8 •Sources of long-term finance

Table 8.2Standard and Poor’s loan notes credit ratings

Rating Explanation

AAA The capacity of the issuing business to meet its obligations is extremely high

AA Slightly lower rated than ‘triple-A’ (AAA), but still very high

A More susceptible to changes in the business/environment than ‘double-A’ loan

notes, but still a high rating

BBB Such loan notes are fairly safe but still more susceptible to adverse changes

than ‘single-A’ loan notes

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BB Major uncertainties as to its safety in the event of adverse changes to the

business/economic environment

B More risky than ‘double-B’ loan notes, but currently able to meet its

commitments

CCC Currently vulnerable to non-payment of its obligations. Is reliant on

business/economic conditions being favourable

CC Highly vulnerable to non-payment

C Currently highly likely not to be able to meet its obligations

D Currently not meeting its obligations

Source: Information taken from the Standard and Poor’s website (www.standardandpoors.com)

Investors’ ratios

Since profitability per se is of no direct interest to loan notes holders, ratios dealing

with the effective rate of interest (yield) are likely to be of more concern to them.

Two ratios that tend to be widely reported in the media are:

l Flat yield. This is simply the gross interest receivable expressed as a percentage of

the current market value of the relevant amount of loan.

l Redemption yield. Where, as is usually the case, the loan notes are redeemable, the

effective return from owning them may include some capital gain or even loss.

(A capital loss would arise where the current market price is above the redemption

value. This would tend to occur where prevailing rates of interest are below the

coupon rate for the loan notes.)

The gross redemption yield (r) would be given by the following expression:

Current market value = I/(1 +r)t+RV/(1 +r)n

where Iis the annual gross interest payment, RV is the redemption value and n is the

remaining life (in years) of loan notes. Using the annual net (of tax) interest payment

as Iin the expression would give the net redemption yield. This is, in effect, the IRR of

the loan notes, taking account of the current market price, the interest payment during

the rest of the life of the loan notes and the amount that will be received on redemption.

Examples of calculations involving this equation are given in Chapter 10.

n

∑

t= 1

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