Module 47.2: Evaluating Credit Quality

Question 1

What is the drawback of using EBITDA for coverage ratios?

Answer 1

does not adjust for capital expenditures and changes in working capital which is not available to debt holders

Question 2

What is debt to capital?

Answer 2

capital is total liabilities & equity , lower ratio means less credit risk.

Question 3

What is debt to EBITDA?

Answer 3

higher ratio indicates higher leverage and higher credit risk. ratio is more volatile with firms that have volatile earnings

Question 4

How does the credit cycle effect an issuers credit spread?

Answer 4

market perception of overall risk is cyclical, depends on the cycle the credit spread can either be high or low

Question 5

How does economic conditions effect an issuers credit spread?

Answer 5

credit spreads narrow as the economy strengthens and investors expect firms credit metrics to improve.

Question 6

How does financial market performance effect an issuers credit spread?

Answer 6

spreads narrow in strong performing markets overall.

Question 7

How does broker-dealer capital effect an issuers credit spread?

Answer 7

narrower when broker-dealers provide sufficinet capital

Question 8

How does general market demand and suppy effect an issuers credit spread?

Answer 8

narrow at times of high demand.

Question 9

What are the four main considerations for high yield bonds?

Answer 9

liquidity, financial projections, corporate structure, and covenants

Question 10

Why is liquidity critical to evaluate for high yield bond issuers?

Answer 10

high yield issuers have limited access to additional borrowings and available funds tend to be more expensive.

Question 11

What are the six sources of liquidity in order of reliability?

Answer 11

1) cash on hand
2) working capital
3) operating cash flow
4) bank credit
5) equity issued
6) sales of assets

Question 12

what is often more restrictive, bank covenants or bond covenants?

Answer 12

bank covenants.

Question 13

Why is it important for an analyst to assess the willingness for a gov to repay debt?

Answer 13

no legal recourse otherwise

Question 14

What are the five key areas used to assign a credit rating to sovereign debt?

Answer 14

1) institutional assessment - culture of honoring debt, no corruption
2) economic assessment - growth trends, income per capita
3) external assessment - country’s foreign reserves, status in international markets
4) fiscal assessment - ability to cut costs or increase revenue
5) monetary assessment - ability to use monetary policy for domestic objectives