Question

a) Define and explain the following terms:

Secured versus unsecured debt

Senior versus subordinated debt

b)  Compare 30-year bond to a 5-year bond all else equal. Which one is more sensitive to interest rate changes. Why? Please explain.

Answer 1

a. Secured debt is the debt that was issued which is backed by a collateral. As the debt is backed by collateral, the interest charges will be reasonable when compared with unsecured debt.

Unsecured debt is not backed by any asset, it will be given solely based on the creditworthiness of the borrower. As it is was not backed by any asset/collateral, the interest charges will be higher when compared to secured debt

Senior debt has the highest priority to claim their dues in the case a firm goes bankrupt. In general, the senior debt issues/lends by banker/lenders. Unsecured debt doesn't have any asset back up and can't claim dues before senior debt, but only after them. Examples include preferred, common share holders

b. 30 year bond is more sensitive to the interest rates because the risk is higher when a bond has higher maturity. It is very uncertain if bond has higher maturity period which results in more interest rate sensitivity. 5 year time period is far less than 30 year and it is little easy to predict the interest rates trend.