44: Credit Analysis (Fixed Income)

Question 1

refers to the value a bond investor will lose if the issuer defaults

Answer 1

Loss severity (loss given default)

Question 2

Expected loss=

Answer 2

default risk * loss severity

Question 3

percentage of a bond’s value an investor will receive if the issuer defaults

Answer 3

recovery rate

Question 4

Recovery rate=

Answer 4

1- Loss severity (%)

Question 5

the difference in yield between a credit risky bond, and credit risk free bond, with similar maturities

Answer 5

credit/yield spread
credit risky bond will have higher yield

Question 6

Wider spread = ____ bond prices

Answer 6

lower bond prices

Question 7

reflects the creditworthiness of the issuer and liquidity of the market for the bonds

Answer 7

The size of the spread

Question 8

the possibility that a bond’s spread will widen due to: downgrade risk or market liquidity risk

Answer 8

spread risk

Question 9

the risk of receiving less than market value when selling a bond, reflected in the bid-ask spread

Answer 9

market liquidity risk
-greater for less creditworthy and smaller issuer bonds

Question 10

ranks the categories of debt in the event of a default

Answer 10

priority of claims

Question 11

Yield spread=

Answer 11

liquidity premium + credit spread

Question 12

represent a general claim to the issuer’s assets and cash flows; lower priority of claims

Answer 12

unsecured debt

Question 13

Borrower’s ability to repay its debt obligations on time

Answer 13

capacity

Question 14

Asses the quality of tangible assets and their ability to be sold, especially important for less creditworthy companies

Answer 14

Collateral

Question 15

Terms and conditions the borrowers and lenders agree to as part of a bond issue

Answer 15

covenants

Question 16

Refers to management’s integrity and its commitment to repay the loan

Answer 16

character

Question 17

Trust certificates are ____ bonds

Answer 17

secured

Question 18

A change of control put protects lenders by requiring the borrower to buy back its debt in the event of an acquisition

Answer 18

reducing credit risk

Question 19

A limitation on liens limits the amount of secured debt that a borrower can carry

Answer 19

reducing credit risk

Question 20

______ yield spreads reflect deteriorating credit quality or less liquidity

Answer 20

Widening (increasing)

Question 21

cash flows from a subsidiary are used to pay the subsidiary’s debt before they may be paid to the parent company to service its debt

Answer 21

Structural subordination

Question 22

parent company debt is effectively subordinate (lesser in rank) to the subsidiary’s debt

Answer 22

structural subordination

Question 23

Yield volatility is combined with duration to estimate the:

Answer 23

price risk of a bond

Question 24

calculated with the probability of default (estimated from the bond rating) and the estimated recovery value should the bond default

Answer 24

Credit risk

Question 25

rating reflects the borrower's overall creditworthiness

Answer 25

An issuer credit

Question 26

As the credit cycle improves, the credit spread will:

Answer 26

narrow

Question 27

As economy strengthens and metric improve, the credit spread will:

Answer 27

narrow making corporate bonds a good investment, since their prices increase compared to Treasuries

Question 28

real risk free interest rate + expected inflation rate + maturity premium + yield spread (liquidity premium + credit spread) =

Answer 28

yield on an option free corporate bond

Question 29

In times of high demand for bonds, credit spread:

Answer 29

narrows

Question 30

covenant protects lenders by limiting the amount of cash that may be paid to equity holders

Answer 30

A restricted payment covenant

Question 31

net income from operations +depreciation/amortization +deferred taxes +noncash items

Answer 31

Funds from operations (FFO)

Question 32

When supply of bonds is low, credit spreads will:

Answer 32

narrow

Question 33

The possibility that the issuer will fail to meet its obligations under the indenture, for which investors demand a premium above the return on a default-risk-free security.

Answer 33

Default risk

Question 34

The type of credit risk most directly reflected in a bond's rating:

Answer 34

Default risk; Bond ratings indicate default risk

Question 35

The risk that a bond will be reclassified as a riskier security by a credit rating agency

Answer 35

Downgrade risk

Question 36

The risk that the default risk premium on a bond can increase.

Answer 36

Credit spread risk is

Question 37

Those whose cash flows and assets are designated to service the debt of their holding company:

Answer 37

Restricted subsidiaries