Chapter_19 - Chapter 19 Chapter The Analysis of Credit Risk...

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Chapter 19 Chapter 19 The Analysis of Credit Risk
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The Analysis of Credit Risk The Analysis of Credit Risk
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What you will learn from this chapter What you will learn from this chapter How default risk determines the price of credit (the cost of debt capital) What determines default risk How default risk is analyzed How credit scoring models work The difference between Type I and Type II errors is predicting defaults How pro forma analysis aids in assessing default risk How value-at-risk analysis is used to assess default risk How financial planning works
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Default Risk and Default Premiums Default Risk and Default Premiums Required Return on Debt = Risk-free Rate + Default Premium The default premium is determined by the risk that the debtor could default Similar terms: Required return on debt Cost of debt Price of credit
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The Suppliers of Credit The Suppliers of Credit Public debt market investors who include (long-term) bondholders and (short-term) commercial paper holders. Commercial banks that make loans to firms. Other financial institutions such as insurance companies, finance houses and leasing firms make loans, much like banks, but usually with specific assets serving as collateral . Suppliers to the firm who grant (usually short- term) credit upon delivery of goods and services.
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Ratio Analysis for Default Evaluation Ratio Analysis for Default Evaluation Steps: 1. Reformulate financial statements 2. Calculate ratios
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Reformulating the Balance Sheet Reformulating the Balance Sheet for Credit Analysis for Credit Analysis The key idea in the reformulation of the balance sheet is to order assets by liquidity and liabilities by maturity. Annotate as you reformulate. Issues: Detail on different classes of debt and their varying maturities is available in the debt footnotes; this detail can be brought on to the face of reformulated statements. Debt of unconsolidated subsidiaries (where the parent owns less that 50%, but has effective obligations) should be recognized. Long-term marketable securities are sometimes available for sale in the short-term if a need for cash arises. Long-term debt (of similar maturity) can be presented on a net basis. Remove deferred tax liabilities that are unlikely to reverse from liabilities to shareholders’ equity. Add the LIFO reserve to inventory and to shareholder’s equity to convert LIFO to a FIFO basis. Off-balance-sheet debt should be recognized on the face of the statement. Contingent liabilities that can be estimated should be
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This note was uploaded on 10/07/2010 for the course ECTCS ec12947322 taught by Professor Johnathayeri during the Spring '10 term at Life.

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Chapter_19 - Chapter 19 Chapter The Analysis of Credit Risk...

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