Leveraged loan.
In plain English
A leveraged loan is a senior secured loan made to a borrower whose debt load is already high relative to its earnings, which is what the leveraged label refers to. The rate floats above a short-term benchmark, so the interest cost rises and falls with market rates rather than staying fixed. Banks arrange these loans and then sell pieces to funds, insurance companies, and structured vehicles, creating a secondary market where prices move daily. Because they are secured and senior, recoveries after a default tend to be better than for unsecured bonds. They are a standard funding tool in buyouts and large refinancings.
01Why it matters
These loans are packaged into funds and structured products sold to ordinary investors, and their income and their default risk both climb when rates rise.
02The math, step by step
Say a company borrows $200,000,000 at a benchmark plus 4 percentage points. If the benchmark is 5 percent, the rate is 9 percent and annual interest is $18,000,000. If the benchmark climbs to 7 percent, the rate becomes 11 percent and interest becomes $22,000,000, $4,000,000 more with no new borrowing.
Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.
03What this is NOT
A high-yield bond usually pays a fixed rate and is often unsecured. A leveraged loan floats with rates and normally sits ahead of bonds with a claim on collateral. The same company can have both, and they behave differently when rates move.
04Receipts
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Plain-English answers from our glossary. Receipts included. Never advice.
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