DEEP-DIVE LBO MODELING QUIZ FOR ADVANCED FINANCE LEARNERS

DEEP-DIVE LBO MODELING QUIZ FOR
ADVANCED FINANCE LEARNERS

All of the following types of debt are typically "floating-rate" instruments used to finance an LBO EXCEPT:
b b b b b b b b b b b b b b b b




a. Subordinated Notes
b b




b. Term Loan A
b b b




c. Term Loan B
b b b




d. Revolver
b




e. None of the above - correct answersExplanation: The correct answer choice is A. All of the answer
b b b b b b b b b b b b b b b b b




choices listed above with the exception of A are floating-rate debt instruments, meaning that its interest rate
b b b b b b b b b b b b b b b b b




is not fixed (e.g. 8% each year until maturity) but rather tied to something like LIBOR (e.g. LIBOR + 3%). Both
b b b b b b b b b b b b b b b b b b b b b




Term Loans and Revolvers have interest rates that fluctuate, whereas subordinated notes - also referred to as
b b b b b b b b b b b b b b b b b




high-yield debt - have fixed interest rates that do not change over time.
b b b b b b b b b b b b




Which of the answer choices below lists the tranches of LBO debt from Lowest to Highest in terms of typical
b b b b b b b b b b b b b b b b b b b b




interest rates? b




a. Term Loan B; Term Loan A; Revolver; Senior Notes; Subordinated Notes; Mezzanine
b b b b b b b b b b b b




b. Revolver; Senior Notes; Subordinated Notes; Term Loan A; Term Loan B; Mezzanine
b b b b b b b b b b b b




c. Revolver; Term Loan A; Term Loan B; Senior Notes; Subordinated Notes; Mezzanine
b b b b b b b b b b b b

, d. Revolver; Mezzanine; Senior Notes; Subordinated Notes; Term Loan A; Term Loan B - correct
b b b b b b b b b b b b b b b




answersExplanation: The correct answer choice is C. All of the answer choices above represent the various b b b b b b b b b b b b b b b b




tranches of LBO debt, but only answer choice C listed them in the correct order of lowest interest rate to
b b b b b b b b b b b b b b b b b b b b




highest interest rate. Keep in mind that both the Revolver and Term Loans represent "bank debt" which is the
b b b b b b b b b b b b b b b b b b b




most senior of all the debt, thereby making it the least risky and therefore likely to have the lowest interest
b b b b b b b b b b b b b b b b b b b b




rates. Revolvers typically have lower interest rates than Term Loan A because the borrowing is more
b b b b b b b b b b b b b b b b




temporary, and Term Loan A is typically lower than Term Loan B because principal repayments are higher. All
b b b b b b b b b b b b b b b b b b




other forms of debt - senior notes, subordinated notes, Mezzanine - represent the "high- yield" type debt
b b b b b b b b b b b b b b b b b




which is riskier than bank debt and therefore offers a higher yield to investors. Senior Notes are senior to the
b b b b b b b b b b b b b b b b b b b b




other two, so rates tend to be lower, and Mezzanine is the most junior of everything above, so interest rates
b b b b b b b b b b b b b b b b b b b b




(and risk) tends to be highest there.
b b b b b b




Which of the following Debt types is MOST likely to offer a Payment-in-Kind (PIK) option for the interest
b b b b b b b b b b b b b b b b b b




payments?



a. Revolver
b




b. Term Loan B
b b b




c. Senior Notes
b b




d. Subordinated Notes
b b




e. Mezzanine - correct answersExplanation: PIK options do not exist for the Revolver or for Term Loans
b b b b b b b b b b b b b b b b b




because PIK always adds to the risk of the Debt, and these are the least risky (and lowest potential return)
b b b b b b b b b b b b b b b b b b b b




forms of Debt. PIK is also extremely unlikely for Senior Notes because although they are classified as "High-
b b b b b b b b b b b b b b b b b




Yield," they are still less risky than the others in this list. PIK may sometimes exist for Subordinated Notes, but
b b b b b b b b b b b b b b b b b b b b




remember that these notes are still senior to Mezzanine - so PIK is definitely the most likely for Mezzanine
b b b b b b b b b b b b b b b b b b b




rather than the others here. In practice, PIK tends to be most common in economic booms when financing is
b b b b b b b b b b b b b b b b b b b




cheap and less common when financing tightens up and it gets harder to borrow money - because it greatly
b b b b b b b b b b b b b b b b b b b




increases the credit risk of the borrower. b b b b b b




Which of the following tranches of LBO debt below have Maintenance Covenants rather than Incurrence
b b b b b b b b b b b b b b b




Covenants?