44: Credit Analysis (Fixed Income) Flashcards
refers to the value a bond investor will lose if the issuer defaults
Loss severity (loss given default)
Expected loss=
default risk * loss severity
percentage of a bond’s value an investor will receive if the issuer defaults
recovery rate
Recovery rate=
1- Loss severity (%)
the difference in yield between a credit risky bond, and credit risk free bond, with similar maturities
credit/yield spread
credit risky bond will have higher yield
Wider spread = ____ bond prices
lower bond prices
reflects the creditworthiness of the issuer and liquidity of the market for the bonds
The size of the spread
the possibility that a bond’s spread will widen due to: downgrade risk or market liquidity risk
spread risk
the risk of receiving less than market value when selling a bond, reflected in the bid-ask spread
market liquidity risk
-greater for less creditworthy and smaller issuer bonds
ranks the categories of debt in the event of a default
priority of claims
Yield spread=
liquidity premium + credit spread
represent a general claim to the issuer’s assets and cash flows; lower priority of claims
unsecured debt
Borrower’s ability to repay its debt obligations on time
capacity
Asses the quality of tangible assets and their ability to be sold, especially important for less creditworthy companies
Collateral
Terms and conditions the borrowers and lenders agree to as part of a bond issue
covenants
Refers to management’s integrity and its commitment to repay the loan
character
Trust certificates are ____ bonds
secured
A change of control put protects lenders by requiring the borrower to buy back its debt in the event of an acquisition
reducing credit risk
A limitation on liens limits the amount of secured debt that a borrower can carry
reducing credit risk
______ yield spreads reflect deteriorating credit quality or less liquidity
Widening (increasing)
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
Structural subordination
parent company debt is effectively subordinate (lesser in rank) to the subsidiary’s debt
structural subordination
Yield volatility is combined with duration to estimate the:
price risk of a bond
calculated with the probability of default (estimated from the bond rating) and the estimated recovery value should the bond default
Credit risk
rating reflects the borrower’s overall creditworthiness
An issuer credit
As the credit cycle improves, the credit spread will:
narrow
As economy strengthens and metric improve, the credit spread will:
narrow
making corporate bonds a good investment, since their prices increase compared to Treasuries
real risk free interest rate
+ expected inflation rate
+ maturity premium
+ yield spread (liquidity premium + credit spread)
=
yield on an option free corporate bond
In times of high demand for bonds, credit spread:
narrows
covenant protects lenders by limiting the amount of cash that may be paid to equity holders
A restricted payment covenant
net income from operations
+depreciation/amortization
+deferred taxes
+noncash items
Funds from operations (FFO)
When supply of bonds is low, credit spreads will:
narrow
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.
Default risk
The type of credit risk most directly reflected in a bond’s rating:
Default risk;
Bond ratings indicate default risk
The risk that a bond will be reclassified as a riskier security by a credit rating agency
Downgrade risk
The risk that the default risk premium on a bond can increase.
Credit spread risk is
Those whose cash flows and assets are designated to service the debt of their holding company:
Restricted subsidiaries
