AZS AZS As defined by S&P Capital IQ, which of the following ratio categories measures the flexibility to pay short-term obligations and/or mitigate unforeseen contingencies?Į. False True Which of the following is the Bloomberg function for Z-score?Į. Book value of debt to market value of equity Working Capital to total assets Using the Bloomberg Credit Risk Scale, the probability of default for a company ranked IG that does not default should increase over time, while the probability of default for a company ranked DS that does not default should decrease over time.ī. Unable to determine An increase in $300 million in short-term debt Which of the following are inputs to the Altman's Z-score Model?Į. A decrease in $300 million in long-term debtĮ. An increase in $300 million in short-term debtĭ. A decrease in $300 million in long-term debtĬ. An increase in $300 million in long-term debtī. No Change Decrease Which of the following will lead to the GREATEST increase in the Default Probability according to Bloomberg Credit Risk?Ī. False False If the standard deviation of assets increases, the value of risky debt willĬ. No Change Decrease A large ratio of inventory to working capital (relative to the industry average) generally suggests that the quantity of liquidity is poor.ī. Additional ResourcesĬFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst.As a company's leverage ratios increase and solvency ratios decline relative to industry peers, its borrowing capacity will most likely?Ĭ. Therefore, a strong prior belief about the probability of default can influence prices in the CDS market, which, in turn, can influence the market’s expected view of the same probability. This would result in the market price of CDS dropping to reflect the individual investor’s beliefs about Greek bonds defaulting. For example, if the market believes that the probability of Greek government bonds defaulting is 80%, but an individual investor believes that the probability of such default is 50%, then the investor would be willing to sell CDS at a lower price than the market. Like all financial markets, the market for credit default swaps can also hold mistaken beliefs about the probability of default. A credit default swap is basically a fixed income (or variable income) instrument that allows two agents with opposing views about some other traded security to trade with each other without owning the actual security. In the event of default by the Greek government, the bank will pay the investor the loss amount. The investor will pay the bank a fixed (or variable – based on the exact agreement) coupon payment as long as the Greek government is solvent. The investor, therefore, enters into a default swap agreement with a bank. However, due to Greece’s economic situation, the investor is worried about his exposure and the risk of the Greek government defaulting. A credit default swap is an exchange of a fixed (or variable) coupon against the payment of a loss caused by the default of a specific security.Ĭonsider the following example: an investor holds a large number of Greek government bonds. They can be viewed as income-generating pseudo-insurance. What are Credit Default Swaps?Ĭredit default swaps are credit derivatives that are used to hedge against the risk of default. In this case, the probability of default is 8%/10% = 0.8 or 80%. Therefore, the investor can figure out the market’s expectation on Greek government bonds defaulting. The investor expects the loss given default to be 90% (i.e., in case the Greek government defaults on payments, the investor will lose 90% of his assets). The price of a credit default swap for the 10-year Greek government bond price is 8% or 800 basis points. Therefore, the market’s expectation of an asset’s probability of default can be obtained by analyzing the market for credit default swaps of the asset.Ĭonsider an investor with a large holding of 10-year Greek government bonds. Therefore, if the market expects a specific asset to default, its price in the market will fall (everyone would be trying to sell the asset). The market’s view of an asset’s probability of default influences the asset’s price in the market. Probability of Default and Credit Default Swaps Investors use the probability of default to calculate the expected loss from an investment. Within financial markets, an asset’s probability of default is the probability that the asset yields no return to its holder over its lifetime and the asset price goes to zero. The probability of default (PD) is the probability of a borrower or debtor defaulting on loan repayments. Updated MaWhat is Probability of Default?
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