Chap 20

Corporate Bond credit analysis

Q. 1
a. What is difference between a positive and negative covenant?
b. What is the purpose of the analysis of covenants in assessing the credit risk of an
issuer?
Ans:
a. Positive Covenant vs. Negative Covenant:
- Positive covenant involves actions a borrower must take.
- Negative covenant involves restrictions on the borrower's actions.
b. Analysis of Covenants in Credit Risk Assessment:
- Assesses the borrower's ability to meet financial obligations.
- Indicates financial discipline and risk management.
Q.2
a. What is maintenance test?
b. What is a debt incurrence test and when does come into play?
Ans:
a. Maintenance Test:
- Ensures the borrower maintains certain financial ratios.
b. Debt Incurrence Test:
- Determines if additional debt can be incurred.
- Comes into play when considering new borrowing.
Q.3 some credit analyst place less empashis on collateral to covenants and business
risk. Explain why.
Ans:
Credit Analysts and Collateral:
- Some analysts prioritize other risk factors over collateral.
 - Focus on business risk and covenant strength.
Q.4 why do credit analysts begin with an analysis of the industry in assessing the
business risk of a corporate issuer?
Ans:
Industry Analysis in Business Risk Assessment:
- Provides context for a company's operating environment.
- Identifies industry-specific challenges and opportunities.
Q.5 what is the purpose of credit analyst investigating the market structure of an
industry
(Unregulated monopoly, oligopoly, etc.)?
Ans:
Market Structure Investigation:
- Understands industry competitiveness.
- Determines market power dynamics.
Q.6 what should be the focus of an analyst with respect to the regulation of an industry?
Ans:
Focus on Industry Regulation:
- Analysts examine regulatory frameworks.
- Assess impact on business operations and compliance.
Q.7 In analyzing the labor situation in an industry in wjoch a corporate issue operates,
what should the credit analyst examine?
Ans:
Labor Situation Analysis:
- Examines labor relations and potential disruptions.
- Considers impact on business continuity.
Q.8 The underlying economic theory regarding many corporate governance issues is the
principal agency relationship between the senior managers and the shareholders of
corporation. Explain this relationship.
Ans:
Principal Agency Relationship in Corporate Governance:
- Describes the relationship between managers and shareholders.
- Highlights the need for aligning interests.
Q. 9 with respect to corporate governance, what are the mechanics that can mitigate the
likelihood that management will act in its own self-interest?
Ans:
Mechanics to Mitigate Management Self-Interest:
- Independent board oversight.
- Performance-based incentives.
- Shareholder voting rights.
Q. 10
a. What are corporate governance ratings reported to the investing public?
b. Are corporate ratings reported to the investing publin?
C. What factors are considered by services that assign corporate governance ratings?
Ans:
a. Corporate Governance Ratings:
- Reported to assess a company's governance practices.

b. Reporting to the Public:

- Ratings are often disclosed publicly.

c. Factors in Governance Ratings:

- Board structure, transparency, ethics, etc.
Q.11 Explain what a credit analyst should do in preparation for an analysis of the
financial statements.
Ans:
Preparation for Financial Statement Analysis:
- Gather financial statements and related documents.
- Understand industry benchmarks and economic trends.
Q. 12
a. What is the purpose of an interest coverage ratio
b. What does an interest coverage ratio of 1.8× mean?
c. Why are interest coverage ratios typically computed on a pretax basis?
d. Why would a fixed charge coverage ratio be materially different from an interest
coverage ratio?
Ans:

a. interest Coverage Ratio:

- Measures a company's ability to cover interest expenses.
b. Ratio of 1.8x:
- Company earns 1.8 times its interest obligations.

c. Pretax Basis for Ratios:

- Reflects financial performance before taxes.

d. Difference from Fixed Charge Coverage Ratio:

- Includes a broader range of fixed charges.
Q. 13
a. what is the purpose of leverage ratio?
b. What measures are used in a leverage ratio for total capitalization?
C. What is the margin of safety measure?
Ans:
a. Purpose of Leverage Ratio:
- Measures the proportion of debt in a company's capital structure.

b. Measures in Leverage Ratio:

- Debt to equity ratio, debt to capitalization ratio.

c. Margin of Safety Measure:

- Indicates the extent a company can withstand financial stress.
Q.14 why do analysts investigate the bank lines of credit that a corporation has?
Ans:
Investigating Bank Lines of Credit:
- Assesses available credit for liquidity needs.
 - Indicates financial flexibility.
Q.15 explain each of the following
a. Funds from operations
b. Operating cashflow
c. Free operating cashflow
d. Discretionary cash flow
e. Prefinanancing cash flow
Ans:
a. Funds from Operations:
- Operating income + non-cash expenses.

b. Operating Cash Flow:

- Cash generated from core operations.

c. Free Operating Cash Flow:

- Operating cash flow - capital expenditures.

d. Discretionary Cash Flow:

- Free operating cash flow - mandatory obligations.

e. Prefinancing Cash Flow:

- Cash flow before financing activities.

Q.16 in the analysis of net assets, what factors should be considered?

Ans:
Analysis of Net Assets:
- Considers asset composition and quality.
- Evaluates the company's ability to cover obligations.
Q.17
a. What is meant by working capital?
b. Why is an analysis of working capital important?

Ans:
a. Working Capital:
- Current assets - current liabilities.
b. Importance of Working Capital Analysis:
- Indicates short-term liquidity and operational efficiency.
Q. 18 why do analyst of high yield corporate bonds feel that the analysis should be
viewed from an equity analyst ‘s perspective?
Ans:
High-Yield Bond Analysis from Equity Perspective:
- Reflects the higher risk associated with high-yield bonds.
- Requires a more equity-like risk assessment.