CAIA - 29 - Hedge Funds: Credit Strategies Flashcards
(102 cards)
1
Q
___ ___refers to an economic process in which undesirable outcomes occur when parties to a transaction have asymmetric information.
A
Adverse selection refers to an economic process in which undesirable outcomes occur when parties to a transaction have asymmetric information.
2
Q
___ ___occurs after an economic transaction is completed and arises when one party to a transaction changes its behavior and the other party bears the consequences.
A
Moral hazard occurs after an economic transaction is completed and arises when one party to a transaction changes its behavior and the other party bears the consequences.
3
Q
Recovery Rate Equation
A
PV of sum to be recovered / Exposure at Default (EAD)
4
Q
Loss Given Default (LGD) Equation
A
Exposure at Default (1 - Recovery Rate)
5
Q
Expected loss given credit risk equation
A
Loss Given Default (LGD) x Probability of Default (PD)
=
Exposure at Default (EAD) * (1 - Recovery Rate) * PD
6
Q
The ___ approach to modeling credit risk assumes an explicit relationship between a firm’s capital structure and default, and describes the value of a firm’s assets as being equal to the value of its equity plus the value of its debt.
A
The structural approach to modeling credit risk assumes an explicit relationship between a firm’s capital structure and default, and describes the value of a firm’s assets as being equal to the value of its equity plus the value of its debt.
7
Q
Under the structural approach, the firm’s equity is considered a ___ ___on its assets, with a strike price equal the face value of its ___due at ___date.
A
Under the structural approach, the firm’s equity is considered a call option on its assets, with a strike price equal the face value of its debt due at exercise date.
8
Q
The ___-___approach to modeling credit risk models default as an exogenous event driven by a random signal.
A
The reduced-form approach to modeling credit risk models default as an exogenous event driven by a random signal.
9
Q
The ___ approach to modeling credit risk involves examining the financial data of companies that have defaulted to try and understand their credit risk.
A
The empirical approach to modeling credit risk involves examining the financial data of companies that have defaulted to try and understand their credit risk.
10
Q
The best known structural credit risk model is the ___ model.
A
The best known structural credit risk model is the Merton model.
11
Q
Murton Model Equation
A
Assets = Debt + Equity
12
Q
The Murton Model assumes that default occurs at ___. It also assumes that ___is costless, ___and ___can be traded without friction and that debt is a ___-___bond.
A
The Murton Model assumes that default occurs at maturity. It also assumes that bankruptcy is costless, debt and equity can be traded without friction and that debt is a zero-coupon bond.
13
Q
Equity in a merton model equation
A
E = max(A - K, 0)
E = Equity
A = Assets
K = Strike
14
Q
Debt in a merton model equation
A
D = K - max(K - A, 0)
D = Debt
K = Strike
A = Assets
15
Q
Black-Scholes Option Pricing Model
A
16
Q
d = what in black scholes model
A
17
Q
Probability of Default in the Merton Model Equation
A
18
Q
Value of Zero Coupon Debt in Merton Model (equation)
A
19
Q
Spread in Merton Model (Equation)
A
20
Q
The primary advantage of the ___ model is that it has several intuitive properties and serves as a basis for more complex models.
A
The primary advantage of the Merton model is that it has several intuitive properties and serves as a basis for more complex models.
21
Q
The Merton model has several shortcomings:
- It’s model’s parameters are not ___ ___
- It is not successful as explaining the ___ ___ on ___-___ securities
A
The Merton model has several shortcomings:
- It’s model’s parameters are not readily observable
- It is not successful as explaining the credit spread on short-term securities
22
Q
The Merton model has four important properties:
- Sensitivity to ___
- Sensitivity to ___ ___
- Sensitivity to ___
- Sensitivity to ___ ___
A
The Merton model has four important properties:
- Sensitivity to maturity
- Sensitivity to asset volatility
- Sensitivity to leverage
- Sensitivity to riskless rate
23
Q
As time to maturity increases, the credit spread ___ initially, but then ___slightly.
A
As time to maturity increases, the credit spread increases initially, but then declines slightly.
24
Q
As asset volatility increase, the probability of default ___ and the credit spread ___.
A
As asset volatility increase, the probability of default increases and the credit spread increases.
25
As leverage increases, the default probability ___ and the credit spread \_\_\_.
As leverage increases, the default probability **increases** and the credit spread **increases**.
26
The ___ model is a structural credit risk model that estimates the credit risk of debt by considering the loan repayment incentive problem from the perspective of the borrowing firm's equity holders.
The **KMV** model is a structural credit risk model that estimates the credit risk of debt by considering the loan repayment incentive problem from the perspective of the borrowing firm's equity holders.
27
The structural relationship between the MV of a firm's equity and its assets under the KMV model (Equation)
28
Relationship between volatility a firm's assets and equity according to KMV model (equation)
29
The ___ model's default trigger is the face value of the zero coupon bond.
The **merton** model's default trigger is the face value of the zero coupon bond.
30
The ___ model's default trigger is based on a weighted average of face values of short-term and long-term debt.
The **KMV** model's default trigger is based on a weighted average of face values of short-term and long-term debt.
31
The ___ to \_\_\_refers to the number of standard deviations that a firm's assets must lose to decline in value to the default trigger.
The **distance** to **default** refers to the number of standard deviations that a firm's assets must lose to decline in value to the default trigger.
32
Distance to Default Equation
33
The KMV model calculates the ___ \_\_\_ ___ empirically as the ratio of the percentage of firms in a database that defaulted within one year when their asset values placed them n standard deviations away from the default at the start of the year relative to the total population of firms that were n standard deviations away from default.
The KMV model calculates the **expected default frequency** empirically as the ratio of the percentage of firms in a database that defaulted within one year when their asset values placed them n standard deviations away from the default at the start of the year relative to the total population of firms that were n standard deviations away from default.
34
Expected Default Frequency under KMV (Equation)
35
The probability that a firm has survived for t years under the reduced-form model
36
Probability that default takes place between s and t using reduced-form model
37
Zero coupon value under reduced form model
38
Zero coupon value under reduced form model with recovery rate
39
Credit spread under reduced form model
40
The ___ \_\_\_reduced-form credit model assumes that recovery is received at the maturity date.
The **Jarrow** **Turnbull** reduced-form credit model assumes that recovery is received at the maturity date.
41
The \_\_\_-\_\_\_ reduced-form credit model allows the recovery process to occur at any time and sets the recovery amount to a fraction of the non-defaulting bond price at the time of the default.
The **Duffie**-**Singleton** reduced-form credit model allows the recovery process to occur at any time and sets the recovery amount to a fraction of the non-defaulting bond price at the time of the default.
42
In practice, ___ credit models are best suited to fundamental security analysis and \_\_\_-\_\_\_ credit models are used in fast-moving environments.
In practice, **structural** credit models are best suited to fundamental security analysis and **reduced**-**form** credit models are used in fast-moving environments.
43
The advantages of the ___ model is that it links credit risk to the company's fundamentals, explicitly accounts for the borrower's capital structure and allows for the valuation of debt.
The advantages of the **structural** model is that it links credit risk to the company's fundamentals, explicitly accounts for the borrower's capital structure and allows for the valuation of debt.
44
The disadvantages of the ___ model is that it assumes the firm's asset values are known and assumes continuity tradability for corporate debt.
The disadvantages of the **Merton** model is that it assumes the firm's asset values are known and assumes continuity tradability for corporate debt.
45
The disadvantages of the KMV model are:
1. Depends on availability of ___ \_\_\_ \_\_\_
2. Assumes ___ \_\_\_ of default frequency
3. Does not account for ___ \_\_\_ of debt
4. Assumes ___ capital structure.
The disadvantages of the KMV model are:
1. Depends on availability of **publicly traded equity**
2. Assumes **normal distribution** of default frequency
3. Does not account for **all features** of debt
4. Assumes **static** capital structure.
46
The advantage of the \_\_\_-\_\_\_ credit model is that they are flexible and easier to implement and calibrate.
The advantage of the **reduced**-**form** credit model is that they are flexible and easier to implement and calibrate.
47
The disadvantage of the \_\_\_-\_\_\_ model is that they do not provide insight into the link between default and drivers of credit worthiness.
The disadvantage of the **reduced**-**form** model is that they do not provide insight into the link between default and drivers of credit worthiness.
48
Empirical credit models differ from the reduced-form in 2 key ways:
1. They use ___ default data
2. They do not estimate the \_\_\_of \_\_\_or ___ \_\_\_.
Empirical credit models differ from the reduced-form in 2 key ways:
1. They use **historical** default data
2. They do not estimate the **probability** of **default** or **credit spread**.
49
The goal of empirical credit models is to generate a ___ \_\_\_that may be used to rank the riskiness of firms or securities.
The goal of empirical credit models is to generate a **credit score** that may be used to rank the riskiness of firms or securities.
50
\_\_\_ \_\_\_-\_\_\_ model is an econometric credit scoring model based on five financial ratios that can be used to predict financial stress
**Altman's z**-**score** model is an econometric credit scoring model based on five financial ratios that can be used to predict financial stress
51
Altman's Z-Score Equation
52
The ___ \_\_\_/ ___ \_\_\_ratio measures a firm's net liquid assets
The **working capital** / **total assets** ratio measures a firm's net liquid assets
53
The ___ \_\_\_/ ___ \_\_\_ratio measures the relative size of the total amount of reinvested earnings over a firm's entire life.
The **retained earnings** / **total assets** ratio measures the relative size of the total amount of reinvested earnings over a firm's entire life.
54
\_\_\_ / ___ \_\_\_ measures the productivity of a firm's assets
**EBIT** / **Total Assets** measures the productivity of a firm's assets
55
\_\_\_ of \_\_\_/ \_\_\_of \_\_\_represents the amount a firm's assets can decline in value before the firm becomes insolvent.
**MV** of **Equity** / **BV** of **LIabilities** represents the amount a firm's assets can decline in value before the firm becomes insolvent.
56
\_\_\_ / ___ \_\_\_ measures the ability of a firm's assets to generate sales.
**Sales** / **Total assets** measures the ability of a firm's assets to generate sales.
57
3 zones for altman z-score
58
\_\_\_ default occurs when a borrower is in breach of its loan obligations' covenants.
**Technical** default occurs when a borrower is in breach of its loan obligations' covenants.
59
\_\_\_ default occurs when a firm fails to make required interest or principal payments.
**Actual** default occurs when a firm fails to make required interest or principal payments.
60
\_\_\_ \_\_\_are made by vendors that provide goods and services to distressed borrowing firms.
**Trade claims** are made by vendors that provide goods and services to distressed borrowing firms.
61
Distressed debt is typically rated ___ or below.
Distressed debt is typically rated **D** or below.
62
Distressed corporate bonds typically trade with a spread greater than \_\_\_% to comparable treasury bonds.
Distressed corporate bonds typically trade with a spread greater than **10**% to comparable treasury bonds.
63
A bank loan trading at a price of \_\_\_% of par value and a bond trading at a price of \_\_\_% of par value are typically considered distressed.
A bank loan trading at a price of **80**% of par value and a bond trading at a price of **40**% of par value are typically considered distressed.
64
A ___ \_\_\_is classified as default that occurs when a borrower repurchases a creditor's claim for cash.
A **distressed exchange** is classified as default that occurs when a borrower repurchases a creditor's claim for cash.
65
An ___ \_\_\_is classified as default that occurs when a borrower exchanges the original obligation for a new instrument.
An **exchange offer** is classified as default that occurs when a borrower exchanges the original obligation for a new instrument.
66
Business-related issues often require ___ \_\_\_.
Business-related issues often require **operational restructuring**.
67
When a company ___ \_\_\_ ___ it extends the maturity of existing debt.
When a company **terms out** **debt** it extends the maturity of existing debt.
68
What are the 2 restructuring options for distressed companies:
1.
2.
What are the 2 restructuring options for distressed companies:
**1. File for Bankruptcy**
**2. Out-of-Court Restructuring**
69
An out of court restructuring may include an ___ \_\_\_ that provides the company with enhanced flexibility like access to additional debt or liquidity.
An out of court restructuring may include an **accordian feature** that provides the company with enhanced flexibility like access to additional debt or liquidity.
70
U.S. bankruptcy filing typically involves two sections in the U.S. Bankruptcy Code: 1) Chapter \_\_\_, which governs restructuring and 2) Chapter \_\_\_, which governs liquidation.
U.S. bankruptcy filing typically involves two sections in the U.S. Bankruptcy Code: 1) Chapter **11**, which governs restructuring and 2) Chapter **7**, which governs liquidation.
71
Once a debtor files for bankruptcy, it becomes known as the \_\_\_-\_\_\_-\_\_\_.
Once a debtor files for bankruptcy, it becomes known as the **debtor-in-possession**.
72
\_\_\_ \_\_\_, with a \_\_\_of \_\_\_that has already been distributed to and voted on by the creditor class reduces the time and cost of bankruptcy process considerably.
**Prepackaged filings**, with a **plan** of **reorganization** that has already been distributed to and voted on by the creditor class reduces the time and cost of bankruptcy process considerably.
73
Under the 2005 BAPCPA, debtors-in-possession have ___ months to propose a plan of reorganization and \_\_\_more months for the solicitation of a vote.
Under the 2005 BAPCPA, debtors-in-possession have **18** months to propose a plan of reorganization and **20** more months for the solicitation of a vote.
74
A bankruptcy court (can/can not) impose a plan of reorganization on creditors.
A bankruptcy court **can** impose a plan of reorganization on creditors.
**As long as it is fair and equitable**
75
The UK is considered (creditor/debtor) friendly.
The UK is considered **creditor** friendly.
76
A ___ of \_\_\_(UK) is a court-sanctioned restructuring process that enables reorganization of solvent and insolvent companies. It needs to be approved by \_\_\_% of the impacted classes and \_\_\_% of each class of creditors.
A **scheme** of **arrangement** (UK) is a court-sanctioned restructuring process that enables reorganization of solvent and insolvent companies. It needs to be approved by a **50**% of the impacted classes and **75**% of each class of creditors.
77
An ___ of \_\_\_(UK) transfers the debtor's control to an administrator and is intended to restructure insolvent companies.
An **administration** of **restructuring** (UK) transfers the debtor's control to an administrator and is intended to restructure insolvent companies.
78
In general, UK bankruptcy laws are moving (closer to/further from) U.S. Chapter 11 rules that aim to save companies from liquidating.
In general, UK bankruptcy laws are moving **closer to** U.S. Chapter 11 rules that aim to save companies from liquidating.
79
In France, the ___ typically take priority during a restructuring.
In France, the **workers** typically take priority during a restructuring.
80
Outside of the U.S. and Europe, bankruptcy laws (are/are not) well developed.
Outside of the U.S. and Europe, bankruptcy laws **are not** well developed.
81
The \_\_\_-to-\_\_\_approach can be considered a relatively hostile strategy that involves an investor providing a loan to a company and ultimately taking control.
The **loan**-to-**own** approach can be considered a relatively hostile strategy that involves an investor providing a loan to a company and ultimately taking control.
82
The ___ distressed investing strategy involves an investor buying a distressed borrower's bond or loan, holding the instrument through workout/bankruptcy, swapping part or all of the debt claims for the reorganized entity's equity, and exiting via sale to a strategic buyer or the public market via an initial public offering.
The **classic** distressed investing strategy involves an investor buying a distressed borrower's bond or loan, holding the instrument through workout/bankruptcy, swapping part or all of the debt claims for the reorganized entity's equity, and exiting via sale to a strategic buyer or the public market via an initial public offering.
83
The \_\_\_-oriented distressed strategy is a non-control-oriented strategy that aims to capture the excess premium in debt instruments that are oversold when non-economic sellers liquidate their holdings.
The **trading**-oriented distressed strategy is a non-control-oriented strategy that aims to capture the excess premium in debt instruments that are oversold when non-economic sellers liquidate their holdings.
84
Trading oriented distressed strategies are best suited to ___ restructurings with \_\_\_buyers and sellers.
Trading oriented distressed strategies are best suited to **large** restructurings with **several** buyers and sellers.
85
DIP loans have a ___ coupon rate and are issued at a \_\_\_to par. They also have \_\_\_-\_\_\_status.
DIP loans have a **higher** coupon rate and are issued at a **discount** to par. They also have **super**-**seniority** status.
86
An \_\_\_-\_\_\_ ___ is a secured loan backed by different types of collateral pledged by a borrower.
An **asset**-**based loan** is a secured loan backed by different types of collateral pledged by a borrower.
87
ABL lenders use a ___ \_\_\_to determine the amount of credit to extend to a borrower.
ABL lenders use a **borrowing** **base** to determine the amount of credit to extend to a borrower.
88
The type of eligible collateral and the assets in the collateral package determine the ___ \_\_\_, which is the ratio of credit for every dollar of collateral.
The type of eligible collateral and the assets in the collateral package determine the **advance rate**, which is the ratio of credit for every dollar of collateral.
89
A ___ \_\_\_temporarily provides a higher advance rate to account for seasonal effects when borrowers need more working capital.
A **seasonal overadvance** temporarily provides a higher advance rate to account for seasonal effects when borrowers need more working capital.
90
Advance rates on typical accounts receivable are \_\_\_-\_\_\_%
Advance rates on typical accounts receivable are **75**-**85**%
91
A ___ \_\_\_provides a higher advance rate, where the additional borrowing is amortized over several years.
A **traditional overadvance** provides a higher advance rate, where the additional borrowing is amortized over several years.
92
\_\_\_ overadvances are typically used with corporate acquisitions or leveraged buyouts.
**Traditional** overadvances are typically used with corporate acquisitions or leveraged buyouts.
93
Smaller and midsize borrowers use ABLs (more/less) extensively in their capital structure.
Smaller and midsize borrowers use ABLs **more** extensively in their capital structure.
94
Typical ABL credit facilities are composed of a ___ \_\_\_or a \_\_\_.
Typical ABL credit facilities are composed of a **term loan** or a **revolver**.
95
A ___ \_\_\_is secured against long-term assets and has an amortizing or a bullet structure.
A **term loan** is secured against long-term assets and has an amortizing or a bullet structure.
96
A term loan typically makes up \_\_\_% or less of the total ABL facility.
A term loan typically makes up **33**% or less of the total ABL facility.
97
A ___ is a credit line with a preapproved limit available for a specific time period.
A **revolver** is a credit line with a preapproved limit available for a specific time period.
98
ABLs (do/do not) typically have leverage covenants.
ABLs **do not** typically have leverage covenants.
99
ABL lenders typically use the ___ \_\_\_ ___ credit metric.
ABL lenders typically use the **fixed charge coverage** credit metric.
100
Fixed Charge Coverage Ratio (equation)
101
In some ABL facilities, the fixed charge covenant is a ___ covenant, that is, it is not effective until the borrower's unused loan capacity falls below a certain level.
In some ABL facilities, the fixed charge covenant is a **springing** covenant, that is, it is not effective until the borrower's unused loan capacity falls below a certain level.
102
Asset Based Lending Strategies face the following unique risks:
1. V
2. P
3. H
4. L
5. T
Asset Based Lending Strategies face the following unique risks:
1. Valuation
2. Process and people
3. Hedging
4. Legal
5. Timing
