Session 14 - Fixed Income Valuation Flashcards
4 C’s of Credit Analysis
A common way to categorize the key components of credit analysis:
- Capacity
- Collateral
- Covenants
- Character
The 4 Profit and Cash Flow metrics used for ratio analysis by credit analysts
- EBITDA
- FFO
- FCF before dividends
- FCF after dividends - want this greater than zero.
3 Leverage metrics commonly used in ratio analysis by credit analysts
- Debt/capital - lower = better
- Debt/EBITDA - lower = better
- FFO/debt - higher = better
2 Coverage ratios used to measure borrower’s ability to generate cash flow for interest payments
- EBITDA/interest expense
2. EBIT/interest expense
6 Sources of liquidity (in order of reliability)
- Balance sheet cash
- Working capital
- Operating cash flow
- Bank credit
- Equity issues
- Sales of assets
Yield Curve Parallel Shift
All yields on all maturities change in the same direction by the same amount.
Yield Curve Twists
Changes where the slope becomes either flatter or steeper. A flattening of the yield curve means the spread between short and long-term rates has narrowed; the curve gets steeper when spreads widen.
Yield Curve Butterfly Shifts
Changes in the degree of curvature. A positive butterfly means that the yield curve has become less curved. If rates increase, the short and long-term maturity yields increase by more than the intermediate maturity yields. A negative butterfly means that there is more curvature to the yield curve. If rates increase, intermediate term yields increase by more than the long and short-term maturity yields.
Pure (Unbiased) Expectations Theory
Suggests that forward rates are solely a function of expected future spot rates. In other words, long-term interest rates equal the mean of future expected short-term rates.
Shortcomings of Pure Expectations Theory
Fails to consider the riskiness of bond investing (price risk & reinvestment risk).
Barbell Portfolios
Contain a relatively large percentage of long and short maturity bonds.
Ladder Portfolios
Contain bonds that are evenly distributed throughout the maturity spectrum.
Bullet Portfolios
Typically has a high concentration of bonds at some intermediate maturity.
Nominal Spread
The bond’s yield to maturity minus the yield on a comparable-maturity treasury benchmark security. The problem with this spread is that is uses a single interest rate to discount each cash flow that makes up the bond; if the yield curve is not flat, each cash flow should instead be discounted at the appropriate spot rate for that maturity.
Z-Spread
The spread that when added to each spot rate on the yield curve, makes the present value of the bond’s cash flows equal to the bond’s market price. Therefore, it is a spread over the entire spot rate curve. The term zero volatility in the Z-spread refers to the fact that is assumes interest rate volatility is zero.
