Debt Financing & Credit Risk | Part 8 – Principles of Corporate Finance (14th)

This comprehensive unit explores the complex mechanisms of debt financing, focusing on credit risk, the diversity of debt instruments, and the strategic utility of leasing. It begins by examining why corporate debt requires a higher yield than government securities, distinguishing between the promised yield and the expected yield which accounts for the statistical probability of default. A central concept is the interpretation of default as a put option held by shareholders; if a firm's asset value falls below its debt obligations, owners can essentially "sell" the company to creditors for the face value of the debt. This framework allows for the valuation of risky debt using structural models like the Merton model and statistical bankruptcy predictors like the Altman Z-score. The discussion extends into the practicalities of bond contracts, detailing the importance of seniority, security through collateral such as mortgage bonds or equipment trust certificates, and the role of protective covenants in mitigating agency conflicts between stockholders and lenders. The unit also covers modern financial innovations, including the securitization of assets into mortgage-backed securities and the use of hybrid instruments like convertible bonds and warrants that offer lenders potential equity participation. Finally, the analysis shifts to leasing, categorizing agreements into short-term operating leases and long-term financial leases. Financial leases are analyzed as a form of secured debt, where the decision to lease versus borrow depends on a net present value calculation. This valuation highlights how tax shields and differing tax positions between the lessor and lessee can create mutual financial advantages, ultimately demonstrating how various forms of debt and lease structures are tailored to meet the specific liquidity and risk-management needs of a corporation.


📘 Read full blog summaries for every chapter:
https://lastminutelecture.com

📘 Have a book recommendation? Submit your suggestion here:
https://forms.gle/y7vQQ6WHoNgKeJmh8

Thank you for being a part of our little Last Minute Lecture family!

⚠️ Disclaimer: These summaries are created for educational and entertainment purposes only. They provide transformative commentary and paraphrased overviews to help students understand key ideas from the referenced textbooks. Last Minute Lecture is not affiliated with, sponsored by, or endorsed by any textbook publisher or author. All textbook titles, names, and cover images—when shown—are used under nominative fair use solely for identification of the work being discussed. Some portions of the writing and narration are generated with AI-assisted tools to enhance accessibility and consistency. While every effort has been made to ensure accuracy, these materials are intended to supplement—not replace—official course readings, lectures, or professional study resources. Always refer to the original textbook and instructor guidance for complete and authoritative information.