if you issue bonds and use the proceeds to buy back stock how des this effect th

Question

if you issue bonds and use the proceeds to buy back stock how des this effect the leverage. look up news on the JPM buyback of stock and discuuss it. relate it to this issue

Explanation / Answer

If a company starts buying back its stocks, it is leveraging its capital structure. When you buy back stocks, the company's equity will decrease and when you issue bonds, the company's debt will increase. As a result Debt/Equity ratio will increase -> Company's beta will change Benefit of doing this 1) Tax shield : Interest you paid can be deducted from gross profit -> You ended up paying less tax and the company's total value will increase 2) Company might do this when it think that its stock is undervalued. Company can buy it now and sell it later at a higher price. Buying back stocks usually get positive reaction from the market since investors might think that the company's stock is undervalued too.

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