"Fixed Income":Fundamentals of Credit Analysis

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Questions 1:

For two equally rated speculative grade bonds, what factor is least likely to account for differences in their valuation?

A 、Severity of loss

B 、Probability of default

C 、Perceived creditworthiness of the companies

Questions 2:

A credit analyst observes the following information for Alpha Co. at fiscal years ending 20X1 and 20X2.

Fixed Income:Fundamentals of Credit Analysis

Based on this information, over this period Alpha’s interest coverage ratio has:

A 、improved.

B、 remained unchanged.

C、 deteriorated.

View answer resolution

【Answer to question 1】B

【analysis】

B is correct. In the case of speculative grade bonds, two bonds with the same credit ratings will tend to have the same probabilities of default. They may still trade at very different valuations because for such bonds the market typically begins focusing on the severity of loss in the event of default, which can be quite different for similarly rated bonds.

A is incorrect because for speculative grade bonds with similar credit ratings the valuations may be quite different if the severity of loss associated with the two bonds is very different from each other.

C is incorrect because if there is a perceived difference in credit quality there is a difference in valuation.

【Answer to question 2】A

【analysis】

A is correct. The company’s interest coverage ratio can be computed as EBITDA/Interest expense. That is:

Fixed Income:Fundamentals of Credit Analysis

The company’s EBITDA interest coverage ratio has improved over this period. If EBIT is used to calculate the coverage ratios, the same conclusion is reached: for 20X1 the ratio is 3.33, and for 20X2 it is 3.86.

B is incorrect because the EBITDA interest coverage ratio has improved over this period.

C is incorrect because the EBITDA interest coverage ratio has improved over this period.

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