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LOS a: Distinguish among default risk, credit spread risk, and downgrade risk. ffice ffice" />
Q1. Which of the following is NOT a component of credit risk?
A) Credit spread risk.
B) Default risk.
C) Interest rate risk.
Correct answer is C)
Credit risk is made up of 3 components that include default risk, credit spread risk and downgrade risk.
Q2. Credit ratings measure which type of risk associated with credit obligations?
A) Credit risk.
B) Downgrade risk.
C) Default risk.
Correct answer is C)
Credit ratings focus on the risk of default based on a number of quantitative measures.
Q3. The risk that the borrower will fail to repay the credit obligation is referred to as:
A) default risk.
B) credit spread risk.
C) credit risk.
Correct answer is A)
Default risk is the risk that the creditor will fail to make timely payments of principal and interest.
Q4. The risk that an issuer’s debt obligation will fall in value because the required risk premium for the debt obligation has increased is referred to as:
A) credit risk.
B) credit spread risk.
C) downgrade risk.
Correct answer is B)
If the required risk premium increases, all else being equal, the value of the debt will decrease. This is known as credit spread risk.
Q5. An unanticipated deterioration in the credit quality of an issuer that results in a decline in the price of the issue is referred to as:
A) downgrade risk.
B) credit risk.
C) default risk.
Correct answer is A)
Credit risk encompasses three distinct types of risk: Downgrade risk is the risk that the issue will be downgraded by the credit rating agencies, which will also cause the bond price to fall, and/or cause the bond to underperform its benchmark. Default risk is the risk that the borrower will not repay the obligation. Credit spread risk is the risk that the credit spread will increase and cause the value of the issue to decrease and/or cause the bond to underperform its benchmark.
Q6. Brad Taylor is a portfolio manager for a small firm that caters to high net worth individuals. He invests substantial amounts of his clients’ assets in fixed incomes securities, while his partner deals primarily with his clients’ equity investments. ffice:smarttags" />Taylor’s particular areas of analytical expertise include corporate bonds, asset-backed securities (ABS), and foreign government bonds. Being in a small firm, Taylor is involved in every aspect of managing the fixed income portion of the portfolio, from the initial identification of a potential investment, to the analysis, and on to the purchase decision. In addition, he also performs an ongoing analysis of assets currently held in the portfolio.
As the size of the portfolio has grown over the past two years, Taylor has become increasingly aware of the fact that he needs to acquire additional support staff in order to adequately perform his fiduciary duties. He has recently hired a new trading assistant, Donald Johnson, whose prior position was at a firm that invested exclusively in equity securities. Johnson has not had much experience in the analysis of fixed income securities and realizes that there are some significant differences between the credit analyses of equities versus that of fixed income securities. He is trying to understand how to evaluate the credit quality of fixed income securities in the specific sectors of corporate bonds, ABS, and foreign government bonds. Taylor suggests that to begin, Johnson should review one of Taylor’s old fixed income textbooks, to become more familiar with the concepts. Johnson needs to be able to identify which key ratios are used in fixed income analysis, how to calculate them, and the how to interpret them. He is familiar with basic mechanics of a cash flow analysis of an equity investment, but needs to understand why and how cash flow from operations can affect the value of a fixed income security. In addition, Taylor expects Johnson to quickly have a strong working knowledge of each of the following areas: corporate bonds and the measurement of their capitalization and solvency; ABS and the factors that will determine an issue’s rating; and foreign government bonds and the economic and political risks that can affect their performance.
Johnson is not sure what is meant by a short-term solvency ratio. Which of the following ratios is a measure of short-term solvency?
A) Current ratio.
B) EBIT interest coverage ratio.
C) Total debt to capitalization ratio.
Correct answer is A)
The current ratio is defined as current assets divided by current liabilities. It is a measure of the adequacy of liquid assets for meeting short-term obligations as they come due.
The total debt to capitalization ratio is equal to the sum of current liabilities and long-term debt divided by the sum of long-term debt and shareholders’ equity. It includes longer term assets and liabilities that are not as liquid.
The EBIT interest coverage ratio is earnings before interest and taxes divided by the annual interest expense. It is not a suitable measure of short-term solvency. (Study Session 14, LOS 52.c)
Q7. Johnson has read about the importance of coverage ratios in order to evaluate the credit risk of a corporate bond. Which of the following statements is most correct? Coverage ratios are used to:
A) judge the capital adequacy of liquid assets for meeting short-term obligations as they come due.
B) determine the capital adequacy of long-term assets to meet long-term debt obligations.
C) test the adequacy of cash flows generated through earnings for purposes of meeting debt and lease obligations.
Correct answer is C)
Examples of coverage ratios are: EBIT interest coverage ratio, EBITDA interest coverage ratio, funds from operations to total debt ratio, and free operating cash flow to total debt ratio. (Study Session 14, LOS 52.c)
Q8. Johnson asks Taylor to define a discretionary cash flow. Which of the following is the most correct? A discretionary cash flow:
A) may be spent at the company's discretion.
B) remains available after a company services its debt.
C) remains available to a company after it funds its operating requirements and capital expenditures.
Correct answer is C)
Discretionary cash flow can be defined as cash flow that is available to a firm after it has funded its basic operating requirements and can be calculated as:
discretionary cash flow = cash flow from operations ? nondiscretionary capital expenditures
Nondiscretionary capital expenditures are those required to maintain the productive capacity of the firm's existing fixed assets and the company's competitive position in its industry. (Study Session 14, LOS 52.e)
Q9. Johnson turns his attention to ABSs. Which of the following is the least important factor considered by rating agencies in assigning a credit rating to ABS?
A) Quality of the seller/servicer.
B) Covenants of the lending agreement.
C) Cash flow stress and payment structure.
Correct answer is B)
Lending agreement covenants are not a major factor considered by rating agencies.
The role of the servicer is critical in an asset-backed security transaction. Therefore, rating agencies look at the ability of a servicer to perform all the activities that a servicer will be responsible for.
The payment structure of an asset-backed security transaction can be either a passthrough or pay through structure. This has important implications for the distribution of the cash flows to the different tranches of the security. (Study Session 14, LOS 52.b)
Q10. Taylor explains to Johnson that there are major differences between ABS and corporate bonds in terms of credit risk. Which of the following is a major difference? ABS have:
A) a greater predictability of cash flows due to the absence of operational risk.
B) a smaller predictability of cash flows due to the higher operational risk.
C) the same predictability of cash flows but a lower operational risk.
Correct answer is A)
In an ABS transaction the role of the servicer is to simply collect the cash flows. There is no active management with respect to the collateral and so very little operational risk associated with cash flows. Conversely, corporate management includes tremendous operational risk. (Study Session 14, LOS 52.a, b)
Q11. Taylor tries to explain the subtleties of foreign sovereign debt to Johnson. Which of the following is least likely a factor used in assessing the credit quality of a national government's local currency debt?
A) Monetary policy and inflation pressures.
B) Balance of payments and external balance sheet structure.
C) Income and economic structure.
Correct answer is B)
In assessing the credit quality of local currency debt, only domestic government policies that emphasize fostering or impeding timely debt service are considered. Only for foreign currency debt will credit analysis focus on the interaction of domestic and foreign government policies as measured by a country's balance of payments and the structure of its external balance sheet. (Study Session 14, LOS 52.d)
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发表于 2009-3-12 11:04
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