Senior Debt

Definition

Senior Debt refers to loans or debt securities that have priority over other debts and equity on a corporation’s assets in the event of liquidation. This type of debt has the first claim on the company’s cash flows and assets before any other obligations. Because of this higher priority, senior debt is considered safer for lenders or investors and typically carries a lower interest rate than junior or subordinated debt.

Examples

Corporate Bonds: These are often issued as senior debt, providing bondholders with a primary claim on the issuing company’s assets if it declares bankruptcy.
Senior Secured Loans: Loans secured by collateral (like real estate or equipment) that ensures repayment by liquidating the asset if the borrower defaults.
Credit Lines: Some businesses secure lines of credit that rank as senior debt, giving lenders primary access to assets in case of default.

Frequently Asked Questions

1. What is the difference between senior debt and subordinated debt?

Senior debt has priority over subordinated debt in claims on assets during liquidation, making it less risky and typically bearing a lower interest rate.

2. How does senior debt affect a company’s capital structure?

Senior debt influences a company’s capital structure by affecting its leverage and risk profile. It must be serviced before any other debts and equity distributions.

3. Why do lenders prefer senior debt?

Lenders prefer senior debt due to its priority in claims, which reduces their risk exposure in case the borrower defaults or goes bankrupt.

4. What are typical interest rates for senior debt compared to junior debt?

Because senior debt carries lower risk, it generally has lower interest rates compared to junior or subordinated debt.

5. Can senior debt include working capital loans?

Yes, senior debt can include working capital loans, which are necessary for day-to-day business operations and are often prioritized in the capital structure.

Junior Debt: Debt that is subordinate to senior debt and has lower priority in claims on assets.
Secured Debt: Debt backed by collateral to minimize risk in case of default.
Unsecured Debt: Debt that is not backed by collateral and thus carries higher risk.
Lien: A legal right against an asset, which can be used to secure senior debt.
Liquidation: Process of selling off assets to settle debts when a company is insolvent.
Bankruptcy: Legal process where companies unable to meet their debt obligations may have their assets distributed.

References

Suggested Books for Further Studies

Principles of Corporate Finance by Richard A. Brealey, Stewart C. Myers, and Franklin Allen
The Handbook of Fixed Income Securities by Frank J. Fabozzi
Corporate Finance by Jonathan Berk and Peter DeMarzo
Debt Markets and Analysis by R. Stafford Johnson

Fundamentals of Senior Debt: Corporate Finance Basics Quiz

### Which debt has the highest priority claim in the event of a company's liquidation? - [x] Senior Debt - [ ] Junior Debt - [ ] Subordinated Debt - [ ] Equity > **Explanation:** Senior debt has the highest priority claim on a company’s cash flows and assets in the event of liquidation. ### What typically happens to the interest rate on senior debt compared to junior debt? - [x] It is lower - [ ] It is higher - [ ] Interest rates are the same for both - [ ] It is dependent on market conditions only > **Explanation:** Due to lower risk, senior debt generally has a lower interest rate than junior or subordinated debt. ### Why do investors consider senior debt to be less risky? - [ ] It is not subject to market fluctuations - [ ] It is not related to company performance - [x] It has priority claims on assets - [ ] It can be easily converted to equity > **Explanation:** Investors consider senior debt less risky because it has priority claims on the company's assets and cash flows in the event of liquidation. ### In which scenario does senior debt get prioritized? - [ ] When declaring dividends - [ ] During corporate profits distribution - [x] During liquidation - [ ] When issuing new shares > **Explanation:** Senior debt is prioritized during liquidation, where it is paid off before junior debts and equity. ### What type of asset backs senior secured loans? - [x] Collateral - [ ] Equity stakes - [ ] Intangible assets - [ ] Unsecured bonds > **Explanation:** Senior secured loans are backed by collateral such as real estate or equipment, reducing the lender's risk. ### Which of the following is an example of senior debt? - [x] Corporate Bonds - [ ] Common Stock - [ ] Subordinated Loans - [ ] Preferred Stock > **Explanation:** Corporate bonds often fall under senior debt, giving bondholders primary claims on the company’s assets in case of bankruptcy. ### How does adding senior debt affect a company’s leverage? - [ ] Decreases leverage - [x] Increases leverage - [ ] Leverage remains unchanged - [ ] It depends on total equity > **Explanation:** Adding senior debt increases the company’s leverage by raising the proportion of debt financing. ### What legal right allows a lender to secure an asset for senior debt recovery? - [ ] Guarantee - [ ] Covenant - [ ] Indenture - [x] Lien > **Explanation:** A lien is a legal right granted to a lender to secure an asset for debt recovery, especially in senior debt agreements. ### What type of debt is unsecured and carries higher risk? - [ ] Senior Secured Debt - [ ] Junior Secured Debt - [x] Unsecured Debt - [ ] All forms of debt > **Explanation:** Unsecured debt is not backed by collateral, making it riskier than secured debt types. ### How are working capital loans who have priority claims referred to? - [ ] Subordinated Loans - [x] Senior Debt - [ ] Equity Loans - [ ] Convertible Debt > **Explanation:** Working capital loans with priority claims on assets are categorized as senior debt.

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