Question 1

The two components of credit risk are default probability and:

Accepted Answer

The other two choices, spread risk and market liquidity risk, are not components of credit risk. Loss severity refers to the extent of loss that would occur in the event of default. Therefore, the correct answer is B- loss severity.

Question 2

in order to analyze the collateral of a company a credit analyst should assess the:

Accepted Answer

Assessing the value of the company's assets in relation to the level of debt is the most relevant factor in analyzing the collateral of a company. This will help the credit analyst determine if the company has sufficient assets to cover its debts in case of default. While cash flows and management's strategy are important factors in assessing a company's creditworthiness, they are not directly related to collateral analysis.

Question 3

loss severity is best described as the:

Accepted Answer

Loss severity refers to the percentage of a bond's value (including unpaid interest) that an investor loses in the event of default. Option A is referring to the calculation of expected loss, not loss severity, and option B is referring to recovery rate, which is related to but not the same as loss severity.

Question 4

Holding all other factors constant, the most likely effect of low demand and heavy new issue supply on bond yield spreads is that yield spreads will:

Accepted Answer

Low demand indicates that investors are not interested in purchasing bonds, which will cause bond prices to decrease and yields to increase. Heavy new issue supply means that there is an abundance of bonds available for purchase, which creates a surplus and drives prices down. These two factors combined make the market less attractive for investors, leading to an increase in yield spreads as investors demand a higher return for the added risk. Therefore, yield spreads will widen.

Question 5

Funds from operations (FFo) of Pay Handle ltd increased in 2011. in 2011 the total debt of the company remained unchanged, while additional common shares were issued.Pay Handle ltd's ability to service its debt in 2011, as compared to 2010, most likely:

Accepted Answer

Since the funds from operations (FFO) increased in 2011 and the total debt remained unchanged, it means that the company has more financial resources to service its debt. Additionally, the issuance of additional common shares might have also contributed to an increase in equity, which could improve the company's ability to service its debt. Therefore, Pay Handle ltd's ability to service its debt in 2011 likely improved.

Question 6

The risk that a bond's creditworthiness declines is best described by:

Accepted Answer

Credit migration risk refers to the risk that a bond's credit rating may decline over time, usually due to changes in the issuer's financial condition. This can result in a lower price for the bond and potentially lower returns for the investor. Market liquidity risk refers to the risk of not being able to sell a bond at a fair price due to insufficient market demand or trading volume, and spread widening risk refers to the risk that the difference in yield between a bond and a benchmark rate increases, resulting in a lower price for the bond. While both market liquidity risk and spread widening risk can impact bond prices, they do not specifically capture the risk of creditworthiness declining.

Question 7

in order to determine the capacity of a company, it would be most appropriate to analyze the:

Accepted Answer

The answer of in order to determine the capacity of...

Question 8

- Depreciation and amortization: $€ 249$ million
- Total assets: $€ 10,618$ million
- Total debt: $€ 1,613$ million
- Shareholders' equity: $€ 4,616$ million
The debt/capital ratio of Adidas AG is closest to:
A. 15.19\%.
B. $25.90 \%$.
C. $34.94 \%$.

Accepted Answer

The answer of - Depreciation and amortization: $€ 249$ million
-...

Question 9

Stedsmart ltd and Fignermo ltd are alike with respect to financial and operating char- acteristics, except that Stedsmart ltd has less publicly traded debt outstanding thanFignermo ltd. Stedsmart ltd is most likely to have:

Accepted Answer

Stedsmart ltd, having less publicly traded debt, is likely to have higher market liquidity risk because there are fewer opportunities for trading, making it harder to buy or sell without affecting the price.

Question 10

during bankruptcy proceedings of a firm, the priority of claims was not strictly adhered to. Which of the following is the least likely explanation for this outcome?

Accepted Answer

The value of secured assets being less than the amount of the claims does not directly explain why the priority of claims was not adhered to during bankruptcy proceedings. The priority of claims typically dictates the order in which creditors are paid, regardless of the value of secured assets.

Question 11

based on the information provided in Exhibit 1, the EbiTdA interest coverage ratio of Adidas AG is closest to:

Accepted Answer

The answer of based on the information provided in Exhibit...

Question 12

if goodwill makes up a large percentage of a company's total assets, this most likely indi- cates that:

Accepted Answer

Goodwill represents the premium paid by a company for an acquired asset or business, over and above its book value. Therefore, a large percentage of goodwill on a company's balance sheet indicates that a significant portion of its assets are not of high quality, as they have been acquired at a premium. This can be indicative of poor investment decisions, excessive acquisition activity, or even potential impairment of the goodwill itself, all of which can negatively impact the company's financial health and stability.

Question 13

based on the information in Exhibit 2, Grupa Zywiec SA's credit risk is most likely: ExHibiT 2 European Food, beverage, and Tobacco industry and Grupa Zywiec SA Selected Financial Ratios for 2010
$\begin{array} { l c c c c c } 
& \begin{array} { c } 
\text { Total } \
\text { debt/Total } \
\text { capital } \
( \% )
\end{array} & \begin{array} { c } 
\text { FFO/Total } \
\text { debt } \
( \% )
\end{array} & \begin{array} { c } 
\text { Return on } \
\text { capital } \
( \% )
\end{array} & \begin{array} { c } 
\text { Total debt/ } \
\text { EBITDA } \
( \mathrm { x } )
\end{array} & \begin{array} { c } 
\text { EBITDA } \
\text { interest } \
\text { coverage } \
( \mathrm { x } )
\end{array} \
\hline \text { Grupa Zywiec SA } & 47.1 & 77.5 & 19.6 & 1.2 & 17.7 \
\text { Industry Median } & \mathbf { 4 2 . 4 } & \mathbf { 2 3 . 6 } & \mathbf { 6 . 5 5 } & \mathbf { 2 . 8 5 } & \mathbf { 6 . 4 5 } \
\hline
\end{array}$

Accepted Answer

Grupa Zywiec SA has a lower credit risk compared to the industry median, as indicated by its higher FFO/Total debt ratio (77.5% vs. 23.6%), higher Return on Capital (19.6% vs. 6.55%), lower Total debt/EBITDA (1.2x vs. 2.85x), and higher EBITDA interest coverage (17.7x vs. 6.45x). These ratios suggest Grupa Zywiec SA is in a stronger financial position to meet its debt obligations than the industry average.

Question 14

A credit analyst is evaluating the creditworthiness of three companies: a construction company, a travel and tourism company, and a beverage company. both the constructionAnd travel and tourism companies are cyclical, whereas the beverage company is non-Cyclical. The construction company has the highest debt level of the three companies. TheHighest credit risk is most likely exhibited by the:

Accepted Answer

The fact that the construction and travel and tourism companies are cyclical indicates that their revenue and income are tied to economic cycles, making them more vulnerable to downturns in the economy. Additionally, the construction company's high debt level increases its financial risk. Therefore, the construction company exhibits the highest credit risk among the three companies. The non-cyclical nature of the beverage company's business reduces its credit risk.

Question 15

Credit risk of a corporate bond is best described as the:

Accepted Answer

Credit risk of a corporate bond is the risk of loss resulting from the issuer failing to make full and timely payments. While A is also partially correct, B is the probability of default or failure to make payments, which is a component of credit risk.

Question 16

For a high-quality debt issuer with a large amount of publicly traded debt, bond investors tend to devote most effort to assessing the issuer's:

Accepted Answer

For a high-quality debt issuer with a large amount of publicly traded debt, bond investors tend to focus their effort on assessing the issuer's likelihood of default, rather than on loss severity or market liquidity risk. This is because default risk is considered the most critical element in determining the creditworthiness of the issuer and the likelihood of the investor being repaid.

Question 17

in the event of default, the recovery rate of which of the following bonds would most likely be the highest?

Accepted Answer

First mortgage debt has the highest recovery rate in the event of default because it is secured by the borrower's property. In the event of default, the lender will have a claim on the property and can sell it to recover the outstanding debt. Senior unsecured debt may have some recovery but it is not secured by any collateral while junior subordinate debt is the last in line for payment and has the least likelihood of recovery.

Question 18

A fixed income analyst is least likely to conduct an independent analysis of credit risk because credit rating agencies:

Accepted Answer

Credit rating agencies may at times mis-rate issues and often lag the market in pricing credit risk, but these are reasons why an analyst would conduct an independent analysis. The inability to foresee future debt-financed acquisitions is not a reason to avoid independent analysis; it's a limitation that affects both analysts and credit rating agencies alike.

Question 19

The risk that the price at which investors can actually transact differs from the quoted price in the market is called:

Accepted Answer

Market liquidity risk refers to the risk that an investor may not be able to buy or sell an investment quickly at the quoted price due to low trading activity or a lack of buyers/sellers in the market. This can lead to a difference between the quoted price and the actual transaction price. Spread risk usually refers to the difference between the bid and ask prices, while credit migration risk refers to the risk of a decrease in the credit rating of a borrower.

Question 20

based on the information in Exhibit 3, the credit rating of davide Campari-Milano S.p.A. is most likely:ExHibiT 3 European Food, beverage, and Tobacco industry; Associated british Foods plc; and
Davide Campari-Milano S.p.A. Selected Financial Ratios, 2010

Accepted Answer

There is no specific credit rating provided in Exhibit 3 for either Associated British Foods plc or Davide Campari-Milano S.p.A. However, we can compare their financial ratios to make an inference about their creditworthiness. Based on the ratios provided, Associated British Foods plc has a higher current ratio (1.42) and a lower debt-to-equity ratio (0.03) compared to Davide Campari-Milano S.p.A. (current ratio of 1.02 and debt-to-equity ratio of 0.46). These ratios suggest that Associated British Foods plc has a stronger financial position and is less risky for lenders, which would likely result in a higher credit rating. Therefore, the credit rating of Davide Campari-Milano S.p.A. is most likely lower than Associated British Foods plc.

Quiz 6: Fundamentals of Credit Analysis