One could define effective yield as the yields of a bond with making use of reinvesting the interest payments of the bond once received. Nominal yield would imply no compounding returns, while effective yield does take this evident power of compounding on investment returns into account. In our paper we assume to find it more realistic to take the effective yields into account as this gives a better view on possible gains on SME bonds for investors.
The influence of risk-free rate
The vast majority of financial risk and returns models ‘start off with an asset that is defined as risk free and use the expected return on that asset as the risk-free rate.’ (Damodaran, 2006) Than with the help of, for instance, CAPM, ‘expected returns on risky investments are then measured relative to the risk-free rate, with the risk creating an expected risk premium that is added on to the risk-free rate.’ (Damodaran, 2006)
The risk-free rate that is used in our regression is computed by Bloomberg; the ten years interest rate on German Government bonds is used, as could be observed on the issue date of the corresponding bond.
Logically when risk-free rate goes up, it is less of investor’s interest to find a return on assets that do bare risk, as the non-risk bearing asset becomes more popular. For this reason it is expected that the effect of risk-free rate has a positive influence on the effective yield. If the risk-free rate increases, it is anticipated that the effective yield goes up, as bond issuers have to increase their interest payments to compete with the increase of risk-free rate to still be able to attract bond investors.
Net debt to EBITDA
Within investment or investment analysis a number of ratios are nowadays used. Our approach makes use of the Net Debt to EBITDA ratio, which provides an insight concerning the amount of leverage. Generally this is processed by taking the interest bearing liabilities subtracted by cash or cash equivalents, divided...