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Unformatted text preview: yst knows that differences due to accounting
method choices or lease reporting choices have been removed. ID11–8
a. A ratings agency is a supposedly independent expert charged with the responsibility of analyzing the
risks associated with debt (and equity) securities. Once the risks have been analyzed and quantified,
the ratings agency assigns a grade (a “rating”) to the security. The lower the risk, the higher the
rating; the higher the risk, the lower the rating. b. Investors interested in purchasing the security will perform their own analysis of the underlying risks but
will also look to the rating as guidance. If the ratings agency assigns a low rating (implying greater risk),
the investor will demand a higher interest rate to compensate for the risks involved. On the other hand, if
the agency assigns a high rating (implying less risk), the investor does not require as high a rate of
interest. As discussed in this chapter, the rate demanded by the investor (the effective rate of interest)
determines the price the investor will pay to purchase the security and receive the stated rate of interest.
If the rate demanded by the borrower (due to the rating of the security), exceeds the stated rate in the
security, the investor will purchase the security at a discount (that is to say, the price of the security will
be below the face value). c. The ratings agency should look at a number of areas, including: the income and credit history of the
individual borrowers (the homeowners), the value of the homes pledged as collateral, the amount of
downpayment made by the borrowers (the initial equity in the house), and the overall health of the housing
market, both nationally and in the local markets where the loans were made. ID11–9
a. The covenant limits the company’s borrowing capacity by stating that funded debt can be no more
than three times EBITDA (a rough estimation of annual cash flow). Since EBITDA was $1,604 million,
funded debt could be no more than $4,812 million. With existing...
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- Fall '08