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Capital structure

The full stack of claims on a company, from secured debt at the top through unsecured and subordinated debt to preferred and common equity at the bottom.

The stack determines who bears losses and in what order, and it is the frame for capital structure arbitrage: buying one layer and shorting another when their prices imply inconsistent views of enterprise value.

A useful discipline is to price the whole company once and then allocate. If the bonds imply a 60% recovery and the equity still carries a meaningful market value, one of the two is wrong, because equity is only worth something when debt is money good.

Example: enterprise value $1.2 billion, secured debt $500 million, senior unsecured $600 million, equity market cap $30 million. Unsecured holders recover $700m / $600m, so they are money good and the equity stub is a thin residual claim.

Related: seniority, subordinated-debt, recovery-rate, distressed-debt, corporate-bond

See it drawn

Original diagrams for the ideas on this page. Illustrative, not real market data.

An equity curve and its drawdownAn account balance rising over a year, falling from a peak to a trough, then climbing back to the old peak.ACCOUNT EQUITY$20k$12k$8k024681012TIME (MONTHS)PEAK $16,000TROUGH $12,000DRAWDOWN−25%RECOVERY
Equity curve and drawdown. An account balance plotted month by month. The fall from the $16,000 peak to the $12,000 trough is a 25% drawdown, and the shaded area lasts until the balance climbs back to the old peak.

Educational only, not advice. Spotted an error? Post in Site Feedback.