Risks in Relying on Ratings from Credit Rating Agencies
[vsw id=”zSl9z7qQB00″ source=”youtube” width=”611″ height=”344″ autoplay=”no”] Investors overwhelmingly believe that credit rating agencies do a good job assessing credit risk. In fact, with a few exceptions (e.g., too high ratings on US subprime mortgage-backed securities issued in the mid-2000s that…
Capacity, Collateral, Covenants, and Character
Traditionally, many analysts evaluated creditworthiness based on what is called the “Four Cs of credit analysis”. Capacity Capacity is the ability of a borrower to service their debt. To be determined, an industry analysis should be conducted. Afterwards the specific…
Financial Ratios Used in Credit Analysis
[vsw id=”zSl9z7qQB00″ source=”youtube” width=”611″ height=”344″ autoplay=”no”] Key credit analysis measures fall into 4 different groups: Profitability and Cash Flows It is from operating cash flows that companies can service their debt payments. The operating income can be obtained by subtracting…
The Credit Quality of a Corporate Bond Issuer
[vsw id=”zSl9z7qQB00″ source=”youtube” width=”611″ height=”344″ autoplay=”no”] To illustrate how to evaluate the credit quality of a corporation, we will look at CVS, a US-based healthcare company. You will be in the shoes of a banker that needs to assess the…
Factors That Influence the Level and Volatility of Yield Spreads
As we saw previously, the yield on a government bond (the benchmark) is: $$\text{Goverment bond yield = Real risk-free interest rate + Expected inflation rate + Maturity premium}$$ To this benchmark yield, we need to add the yield spread, the…
Credit of High Yield, Sovereign, and Non-sovereign Government Debt
[vsw id=”zSl9z7qQB00″ source=”youtube” width=”611″ height=”344″ autoplay=”no”] Special considerations are important when evaluating the creditworthiness of debt issuers in 3 market segments: high-yield corporate bonds, sovereign bonds, and non-sovereign government bonds. High-yield (non-investment-grade or “junk”) corporate bonds are those rated below…
Describe Structured Financial Instruments
Structured financial instruments comprise a range of products designed to repackage and redistribute risk. They are pre-packaged investments based on a single security, a basket of securities, options, commodities, debt issuance or foreign currencies, and to a lesser extent, derivatives. They include asset-backed securities…
Compare, Calculate, and Interpret Yield Spread Measures
Yield spread (measured in basis points) is the difference between any two bond issues and is computed as follows: Yield spread = Yield on Bond 1 – Yield on Bond 2 When the second bond is a benchmark (i.e. Treasury),…
NPV Vs IRR
The net present value (NPV) and the internal rate of return (IRR) are techniques that can both be used by financial institutions or individuals when making major investment decisions. Each method has its own strengths and weaknesses. However, the…
Net Present Value of an Investment Project
The Net present value (NPV) of a project refers to the present value of all cash inflows minus the present value of all cash outflows, evaluated at a given discount rate. The difference between the two represents the income generated…
