Fixed Income: Fundamentals of credit analysis

Question 1

Bond Indenture

Answer 1

The governing legal credit agreement, typically incorporated by reference in the prospectus

Question 2

Capacity

Answer 2

The ability of the borrower to make its debt payments on time

Question 3

Capital Structure

Answer 3

The mix of debt and equity that a company uses to finance its business; a companies specific mixture of long-term financing

Question 4

Change of control put

Answer 4

A covenant giving bondholders the right to require the issuer to buy back their debt, often at par or at some small premium to par value, in the event let that the borrower is acquired

Question 5

Character

Answer 5

The quality of a debt issuers management

Question 6

Collaterals

Answer 6

Assets or financial guarantees underlying a debt obligation that are above and beyond the issuers promise to pay.

Question 7

Covenants

Answer 7

The terms and conditions of lending agreements that the issuer must comply with; they specify the actions that an issuer is obligated to performs (affirmative covenant) or prohibited from performing (negative covenant)

Question 8

Credit curve

Answer 8

A curve showing the relationship between time to maturity and yield spread for an issuer with comparable bonds of various maturities outstanding, usually upward sloping.

Question 9

Credit mitigation risk

Answer 9

The risk that a bond issuer’s creditworthiness deteriorates, or migrated lower, leading investors to believe the risk of default is higher.

Question 10

Cross default provisions

Answer 10

Provisions whereby events of default such as non-payment of interest on one bond trigger default on all outstanding debt; implies the same default probability for all issues.

Question 11

Default probability

Answer 11

The probability that a borrower defaults or fails to meet its obligation to make full and timely payments of principal and interest, according to the terms of the debt security.

Question 12

Default Risk

Answer 12

The probability that a borrower defaults or fails to meet its obligation to make full and timely payments of principal and interest, according to terms of the debt security.

Question 13

Downgrade Risk

Answer 13

The risk that a bonds issuer’s creditworthiness deteriorates, or migrates lower, leading investors to believe the risk of default is higher

Question 14

Expected loss

Answer 14

Default probability times loss severity given default

Question 15

First lien debt

Answer 15

Debt secured by a pledge of certain assets that could include buildings, but may also include property and equipment, licenses, patents, brands etc.

Question 16

First mortgage debt

Answer 16

Debt secured by a pledge of a specific property

Question 17

Limitations on liens

Answer 17

Meant to put limits on how much secured debt an issuer can have

Question 18

Loss severity

Answer 18

Portion of a bonds value (including unpaid interest) an investor loses in the event of default

Question 19

Maintenance covenants

Answer 19

Covenants in bank loan agreements that require the borrower to satisfy certain financing ratio test while the loan is outstanding

Question 20

Market liquidity risk

Answer 20

The risk that the price at which investors can actually transact-buying or selling- may differ from the price indicated in the market.

Question 21

Notching

Answer 21

Ratings adjustment methodology where specific issues from the same borrower may be assigned different credit ratings

Question 22

Pari passu

Answer 22

On an equal footing

Question 23

Priority of claims

Answer 23

Priority of payment, with the most senior or high ranking debt having the first claim on the cash flows and assets of the issuer

Question 24

Prospectus

Answer 24

The document that describes the terms of a new bond issue and helps investors perform their analysis on the issue

Question 25

Restricted payments

Answer 25

A bond covenant meant to protect creditors by limiting how much cash can be paid out to shareholders over time

Question 26

Second lien

Answer 26

A secured interest in the pledged assets that ranks below first lien debt in both collateral protection and priority of payment

Question 27

Secured debt

Answer 27

Debt in which the debt holder has a direct claim- a pledge from the issuer - on certain assets and their associated cash flows

Question 28

Seniority ranking

Answer 28

Priority of payment of various debt obligations

Question 29

Spread risk

Answer 29

Bond price risk arising from changes in the yield spread on credit-risky bonds; reflects changes in markets assessments and or pricing of credit migration (or downgrade) risk and market liquidity risk

Question 30

Structural subordination

Answer 30

Arises in a holding company structure when the debt of operating subsidiaries before funds can be passed to the holding company to service debt at the parent level

Question 31

Subordinated debt

Answer 31

A class of unsecured debt that ranks belies a firm’s senior unsecured obligations

Question 32

Trust deed

Answer 32

The governing legal credit agreement, typically incorporated by reference in the prospectus

Question 33

Unsecured debt

Answer 33

Debt which gives the debtholder only a general claim on an issuers assets and cash flow