With Fixed Income on Fat Tuesday who needs Bourbon Street?
I rarely post but always read (mainly because i dont understand half the subjects)… I am becoming impatient waiting for my lunch crunch today
LOS Explanation Credit risk encompasses three distinct types of risk: Default risk is the risk that the borrower will not repay the obligation. Credit spread risk is the risk that the credit spread will increase and cause the value of an issue to decrease and/or cause the bond to underperform its benchmark. Downgrade risk is the risk that the issue will be downgraded, which will also cause the bond price to fall, and/or cause the bond to underperform its benchmark. LOS Explanation The four Cs of credit analysis are: Character includes integrity of the management and its commitment to repay the loan. Other factors such as corporate governance structure, their business qualifications, and operating record are also important. Covenants are the terms and conditions contained in the lending agreement, and include restrictions placed on management’s ability to make operating and financial decisions in the normal course of business. Collateral includes the assets offered as security for the debt as well as other assets controlled by the issuer. The value of the pledged assets is also an important determinant of the collateral. Collateral analysis is probably the least useful in assessing corporate credit risk. Capacity to pay refers to the corporate borrower’s ability to generate cash flow or liquidate short-term assets to repay its debt obligations. Sources of liquidity include working capital, cash flow, back-up facilities, securitization, third-party guarantees. LOS Explanation Profitability ratios assess the issuer’s ability to generate earnings sufficient to pay interest and repay principal. ROE = NI / equity = (NI/sales)(sales/TA)(TA/equity) Short-term solvency ratios determine the availability of liquid assets to meet short-term obligations. Current ratio = current assets / current liabilities Acid-test ratio = (current assets – inventories) / current liabilities Capitalization ratios (also known as financial leverage ratios) are evaluated with reference to the industry in order to determine the firm’s ability to take on additional risk associated with increased borrowing. Long-term debt to capitalization ratio = long-term debt / (long-term debt + minority interest + shareholders’ equity) Total debt to capitalization ratio = (current liabilities + long-term debt) / (current liabilities + long-term debt + minority interest + shareholders’ equity) Coverage ratios examine the adequacy of cash flows generated through earnings to meet debt and lease obligations. EBIT coverage ratio = EBIT / annual interest expense EBITDA coverage ratio = EBITDA / annual interest expense A major limitation of ratio analysis is that it is not forward looking because it does not consider factors that can affect future cash flows. Ratios represent a snapshot of a particular aspect of a firm’s financial position at a given point in time. They are based on past data. Traditional ratios do not fully reflect cash flow from operations and ignore factors that can alter future cash flows. Ratings reflect future expectations regarding a firm’s cash flows. A firm’s cash flow is a better measure of a firm’s financial position. LOS Explanation The primary source of repayment for debt is cash flow, so an analysis of operating cash flows is critical. The rating agencies use cash flow measures that differ from the framework used in Study Session 12. Net income + depreciation ± other noncash items Funds from operations + decrease (increase) in noncash current assets + increase (decrease) in nondebt current liabilities Operating cash flow – capital expenditures Free operating cash flow – cash dividends Discretionary cash flow – acquisitions + asset disposals + other sources (uses) Prefinancing cash flow LOS Explanation The typical debt structure of a high-yield issuer includes bank debt, reset notes, senior and subordinated debt (which may be zero-coupon). High-yield borrowers typically rely on short-term, floating-rate, senior bank debt to a greater extent than investment grade borrowers. Reset notes trade at a specific premium to their par value, because the coupon rate on a reset note is adjusted periodically. High-yield issuers are often structured as a holding company. Debt is borrowed at the parent level, and funds to pay the obligation in the future are obtained from operating subsidiaries. This makes it imperative that the operating subsidiaries’ financial ratios be examined to determine whether the subsidiaries’ financial position will help the parent meet its obligations and whether the subsidiaries’ own debt covenants will restrict their cash contributions to the parent. LOS Explanation Factors considered by rating agencies with regards to ABS: Collateral credit quality: The borrower’s equity in the underlying asset offered as collateral is the main determinant of whether the borrower will default/sell the asset to pay off a loan. Seller/servicer quality: A third party servicer collects payments, notifies delinquent borrowers, and recovers and disposes of collateral as necessary. Cash flow stress and payment structure: The rating agencies analyze ABS cash flow projections under different scenarios related to losses, delinquencies, and economic conditions, to assess how these cash flows are distributed to the various tranches (bonds) in the asset-backed security structure. This is an important point because the cash flow from the collateral pool may only be sufficient to meet the cash flow requirements of some, but not all, of the various ABS tranches. Legal structure: A firm that securitizes assets can obtain a credit rating on the securities it issues that is higher than the issuer’s corporate credit rating by using a special purpose vehicle (SPV). LOS Explanation For tax-backed debt, credit worthiness is determined by: Issuer’s debt structure. Budgetary policy. Local tax and intergovernmental revenue availability. Issuers’ socioeconomic environment. Revenue bonds are issued by municipalities for financing specific projects and enterprises. Key considerations in the credit analysis are: Limits of the basic security. Flow of funds structure. Rate, or user charge, covenants. Priority-of-revenue claims. Additional-bonds tests.
General Principles of Credit Analysis -------------------------------------------------------------------------------- Question 1 - 88046 Which of the following statements regarding factors considered by rating agencies in rating asset-backed securities is least accurate? A) A firm’s credit rating must be less than or equal to its overall corporate rating. B) The borrower’s equity in an asset that has been offered as collateral is the primary determinant of whether the borrower will default or sell the asset to pay off the loan. C) The servicer of the loan must be evaluated since the servicer is responsible for distributing proceeds to the bondholders, determining the interest rate for the period, and advancing payments when there are delinquencies. -------------------------------------------------------------------------------- Question 2 - 88004 Harold Adams is a financial analyst reviewing the financial data for Butler, Inc., for the years 1999, 2000, and 2001. Information for several selected ratios are given below: Table 1 Selected Data on Butler, Inc. Ratios 2001 2000 1999 Earnings before interest and taxes (EBIT) interest Coverage Ratio 19.5 17.2 13.7 Earnings before interest, taxes, depreciation and amortization (EBITDA) interest coverage 10.0 9.0 8.0 Funds from Operations/Total debt (TD) 48.0 48.0 55.0 Free Operating Cash Flow/TD NA NA NA Pretax Return on Capital 26.0 24.1 18.5 Operating Income/Sales 36.0 36.5 37.8 Long-term debt (LTD)/Capitalization 29.0 28.9 31.8 TD/Capitalization 45.0 58.0 60.2 Adams obtained Standard and Poor’s information about median ratios by credit rating. These ratios are reproduced below: Table 2 Standard & Poor’s Select Median Rating Criteria Ratios AAA AA A BBB BB B EBIT interest Coverage Ratio 12.9 9.2 7.2 4.1 2.5 1.2 EBITDA interest coverage 18.7 14.0 10.0 6.3 3.9 2.3 Funds from Operations/TD 89.7 67.0 49.5 32.3 20.1 10.5 Free Operating Cash Flow/TD 40.5 21.6 17.4 6.3 1.0 (4.0) Pretax Return on Capital 30.6 25.1 19.6 15.4 12.6 9.2 Operating Income/Sales 30.9 25.2 17.9 15.8 14.4 11.2 LTD/Capitalization 21.4 29.3 33.3 40.8 55.3 68.8 TD/Capitalization 31.8 37.0 39.2 46.4 58.5 71.4 What would most likely be the result if Butler were to provide Adams with additional 1999 data? It would: A) distort the financial trend for Butler, Inc. B) provide a stronger basis for a decision concerning the firm’s rating. C) provide no additional value for the analyst. -------------------------------------------------------------------------------- Question 3 - 88015 Which of the following factors used to assess municipal tax-backed debt analyzes the issuer’s ability to manage general operating funds? A) Issuer’s debt structure. B) Local tax and intergovernmental revenue availability. C) Budgetary policy. -------------------------------------------------------------------------------- Question 4 - 88019 The risk that an issuer’s debt obligation will fall in value because the required risk premium for the debt obligation has increased is referred to as: A) credit risk. B) downgrade risk. C) credit spread risk. -------------------------------------------------------------------------------- Question 5 - 88008 Which of the following is least likely a factor used by Standard & Poor’s rating agency to assess the creditworthiness of a government’s foreign currency debt? A) Income and economic structure. B) Net public debt. C) Country’s balance of payments. -------------------------------------------------------------------------------- Question 6 - 87992 Which of the following is least likely considered a strong and reliable source of liquidity for a company undergoing a credit analysis? A) Ability to use asset securitization. B) Contractual back-up facility. C) Line of credit. -------------------------------------------------------------------------------- Question 7 - 88048 Which of the following statements regarding the analysis of covenants for high-yield issuers is least accurate? A) An analysis of covenants is more critical for high-yield issuers than for investment grade issuers. B) An analyst should examine whether a no contest clause exists that may change the priority of the claims of the firm’s debtholders. C) Covenants provide important insight into the issuing company’s strategy. -------------------------------------------------------------------------------- Question 8 - 87955 Which of the following statements regarding the debt structure of a high-yield issuer is least accurate? A) High yield issuers rely on bank loans to a greater extent than investment-grade issuers. B) Senior bondholder claims are subordinate to claims of bank loans. C) A high-yield issuer can rely on a high-interest bank loan to provide liquidity if the firm has sufficient assets to cover at least 70% of the bank’s claim. -------------------------------------------------------------------------------- Question 9 - 87932 Furniture Factory, Inc., is a world-wide industry leader in the office furniture manufacturing industry. Use the following ratio table to answer the next three questions. FFI 2003 FFI 2004 FFI 2005 FFI 2006 Industry 2006 Current Asset 1.5 1.4 1.1 1.0 2.1 Quick 1.2 1.2 0.9 0.9 0.9 Inventory Turnover 12.9 17.8 22.3 33.1 6.2 Times Interest Earned (TIE) 9.5 16.3 27.3 30.7 5.6 Debt to Equity (D/E) 1.3 1.6 2.4 2.6 1.5 Part 1) Which of the following interpretations of ratio analysis is most accurate? A) The liquidity position of Furniture Factory, Inc., has been steadily improving. B) Furniture Factory, Inc., has a higher credit risk than the average company in the industry based on the times interest earned ratio. C) Furniture Factory, Inc., has a higher credit risk than the average company in the industry based on the D/E ratio. Part 2) Which of the following statements describes the most likely interpretation of the liquidity position of Furniture Factory, Inc? Furniture Factory, Inc., has: A) managed their inventory more efficiently than the industry. B) difficulty meeting short-term obligations. C) a serious liquidity problem compared to the industry. Part 3) Based on the ratio analysis table for Furniture Factory, Inc., complete the following statement. Creditors would most likely: A) downgrade the credit quality of Furniture Factory, Inc., and increase the amount of interest charged to cover the increasing default risk. B) not consider lending more money to Furniture Factory, Inc., due to the significant problems that are apparent with both liquidity and leverage. C) require additional information to explain the apparent contradictions in the liquidity and leverage ratios. -------------------------------------------------------------------------------- Question 10 - 87957 Which of the following is least likely a factor used in assessing the credit quality of a national government’s local currency debt? A) Balance of payments and structure of the external balance sheet. B) Income and economic structure. C) Monetary policy and inflation pressures. -------------------------------------------------------------------------------- Question 11 - 88045 Which of the following is most likely to affect the analysis of a firm’s ability to repay the interest and principal components of its debt? A) The level of the company’s debt to total assets ratio. B) The firm’s ability to generate operating cash flows. C) The character of the firm’s management. -------------------------------------------------------------------------------- Question 12 - 88121 Discretionary cash flow is defined as (net earnings + depreciation + deferred income taxes − noncash revenue items included in net earnings − increase in adjusted noncash working capital − capital expenditures − cash dividends). This definition is equivalent to which of the following? A) Cash from financing − dividends payable. B) Free operating cash flow − cash dividends. C) Cash from investing − cash from operations (CFO). -------------------------------------------------------------------------------- Question 13 - 87952 Which of the following factors least likely represents an economic risk that Standard and Poor’s Corporation would consider in the rating of a sovereign debt credit? A) external security risks. B) natural resource endowments. C) living standards. -------------------------------------------------------------------------------- Question 14 - 88024 An unanticipated deterioration in the credit quality of an issuer that results in a decline in the price of the issue is referred to as: A) credit risk. B) downgrade risk. C) default risk. -------------------------------------------------------------------------------- Question 15 - 87991 Which of the following factors is least likely part of the analysis of an issuer’s character? A) Conservatism. B) Executive compensation and benefits structure. C) Succession planning. -------------------------------------------------------------------------------- Question 16 - 87947 Which of the following statements is most accurate regarding the issuance of high yield debt under a holding company structure? A) Debt is borrowed at the parent company level and funds to pay the obligation are obtained from operating subsidiaries. B) The analysis of subsidiary financial ratios and performance is unimportant because the debt repayment is made from the parent’s cash flows. C) Debt is borrowed at the subsidiary level and funds to pay the obligation are obtained from the parent company. -------------------------------------------------------------------------------- Question 17 - 87979 Which of the following 4-C’s of credit refers to the terms and conditions of the lending agreement? A) Contracts. B) Conditions. C) Covenants. -------------------------------------------------------------------------------- Question 18 - 87995 Which of the following focuses on analyzing the quality of management? A) Capacity analysis. B) Character analysis. C) Compensation analysis.
Question 1: 88046 C Question 2: 88004 B Question 3: 88015 C Question 4 – 88019 C Question 5 - 88008 A Question 6 - 87992 B Question 7 - 88048 A Question 8 - 87955 C Question 9 - 87932 Part 1) C Part 2) A Part 3) B Question 10 - 87957 A Question 11 - 88045 B Question 12 - 88121 B Question 13 - 87952 A Question 14 - 88024 B Question 15 - 87991 B Question 16 - 87947 B Question 17 - 87979 C Question 18 - 87995 B
So far i’ve got… Question 1 - 88046 A) A firm’s credit rating must be less than or equal to its overall corporate rating. Question 2 - 88004 B) provide a stronger basis for a decision concerning the firm’s rating. without even reading anything above this seems obvious- if this isn’t the answer, i’m going to let out a giant WTF. Question 3 - 88015 C) Budgetary policy. Question 4 - 88019 C) credit spread risk. Question 5 - 88008 C) Country’s balance of payments. this feels wrong but i didn’t know which to choose Question 6 - 87992 A) Ability to use asset securitization. C) Line of credit. I’m between these 2 but I’m going to go line of credit, C. Question 7 - 88048 A) An analyst should examine whether a no contest clause exists that may change the priority of the claims of the firm’s debtholders. Question 8 - 87955 C) A high-yield issuer can rely on a high-interest bank loan to provide liquidity if the firm has sufficient assets to cover at least 70% of the bank’s claim. Question 9 - 87932 Part 1) C) Furniture Factory, Inc., has a higher credit risk than the average company in the industry based on the D/E ratio. Part 2) A) managed their inventory more efficiently than the industry. hmm… COGS/ave inventory… you’d think if they manage well they don’t have big denominator which would mean a higher inv turnover but what if they just had massive COGS? that wouldn’t be so good. i dunno, i’ll stick by this one Part 3) C i think is wrong b/c the liq/leverage ratios say the same thing- more leverage, less liquidity… b/t A or B… B seems harsh. i mean, there are concerns but not sure they’d just shut the door completely. A I like better- has a high TIE ratio vs industry so maybe they aren’t getting charged much interest? I’ll go A. If i bail on this section shame on me- I just read it this past weekend. I will try to plow through the rest then grab lunch.
Question 10 - 87957 A) Balance of payments and structure of the external balance sheet. crap- this one says local- i bet I f’d the 1st similar q one up. Question 11 - 88045 B) The firm’s ability to generate operating cash flows. Question 12 - 88121 B) Free operating cash flow − cash dividends. Question 13 - 87952 A) external security risks. Question 14 - 88024 A) credit risk. Question 15 - 87991 C) Succession planning. (maybe in covenants? none of these sounded that non-character to me, uh oh) Question 16 - 87947 A) Debt is borrowed at the parent company level and funds to pay the obligation are obtained from operating subsidiaries. Question 17 - 87979 C) Covenants. Question 18 - 87995 B) Character analysis.
Question 1: 88046 C Wrong Question 2: 88004 B Correct Question 3: 88015 C Correct Question 4 – 88019 C Correct Question 5 - 88008 A Correct Question 6 - 87992 B Wrong Question 7 - 88048 A Wrong Question 8 - 87955 C Correct Question 9 - 87932 Part 1) C Correct Part 2) A Correct Part 3) B Wrong Question 10 - 87957 A Correct Question 11 - 88045 B Correct Question 12 - 88121 B Correct Question 13 - 87952 A Correct Question 14 - 88024 B Correct Question 15 - 87991 B Correct Question 16 - 87947 B Wrong Question 17 - 87979 C Correct Question 18 - 87995 B Correct Wrong: 5/20
Q1. A Q2. B Q3. B Q4. B Q5. C Q6. A Q7. C Q8. C Q9. C; A ; C Q10. A Q11. B Q12. A Q13 B Q14. B Q15. B Q16. A Q17 C Q18. B
Had a Mardi Gras specials at office cafeteria… so took longer than usual to get back to the seat. Q1.B Q2.?? Q3.C Q4.C Q5.A Q6.A Q7.B Q8.C Q9PA.C since 1.975 > 1.5 Q9PB.A since everything greater than 6.2 Q9PC. A downgrate because of bad liquidity and high leverage Q10.A (the can print money home) Q11.B (ability to generate OCF) Q12.B (CFC - Div = Discretionary) Q13.A (external security) Q14.B (downgrade) Q15.B (Executive compensation and benefits structure) Q16.A (borrowed at paremnt level and repayed at sub level) Q17.C (Covenants) Q18.B (Character )
Ans Question 1: 88046 A Question 2: 88004 B Question 3: 88015 C Question 4 – 88019 C Question 5 - 88008 A Question 6 - 87992 C Question 7 - 88048 A Question 8 - 87955 C Question 9 - 87932 Part 1) C Part 2) A Part 3) C Question 10 - 87957 A Question 11 - 88045 B Question 12 - 88121 B Question 13 - 87952 A Question 14 - 88024 B Question 15 - 87991 B Question 16 - 87947 A Question 17 - 87979 C Question 18 - 87995 B
5 wrong - Q1, Q2, Q6, Q7, Q9-PartC.
7 Wrongs/20 : 3, 4, 5,6, 7, 12 & 13
this goes to show how retention is strong when you just read it and then fades… only 3x for me, but give me the same test in about 2 weeks and i’m sure that would double and then some. for now, i’ll take the success and say yeehah! i like binomial trees also. SS14 is officially my biyatch.