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Debt at fair value

Some companies borrow money with long maturities . The people who have lent the company this money know they can rely on a defined income until the loan matures. They could sell the debt on to someone else but, if the market rate of interest has changed since they lent the money, the debt is more (if interest rates have fallen) or less (if interest rates have risen) valuable in the eyes of the buyer.

The fair value of the debt is simply its value if you adjust the price of the debt so that a buyer would be earning the market rate of interest.

For example,

Say I borrow £100 for a year at 10% interest, then say the market rate of interest immediately halves to 5%. If I now sell the loan, a buyer is going to get £110 from owning my loan compared to £105 for making a loan in the open market. My loan is worth more to the buyer so he should pay me more. The price he should pay is 110/105 = £104.76.

This is important as investment companies that borrow money for long periods have to publish NAVs that reflect their debt at par (the value as though the market rate of interest hadn’t changed) and debt at fair value.

 

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