27
CHAPTER 5
FUNDAMENTALS OF
CREDIT ANALYSIS
PROBLEMS
1. e risk that a bond’s creditworthiness declines is best described by:
A. credit migration risk.
B. market liquidity risk.
C. spread widening risk.
2. Stedsmart Ltd and Fignermo Ltd are alike with respect to financial and operating char-
acteristics, except that Stedsmart Ltd has less publicly traded debt outstanding than
Fignermo Ltd. Stedsmart Ltd is most likely to have:
A. no market liquidity risk.
B. lower market liquidity risk.
C. higher market liquidity risk.
3. In the event of default, debentures’ claims will most likely rank:
A. above that of secured debt holders.
B. below that of secured debt holders.
C. the same as that of secured debt holders.
4. In the event of default, the recovery rate of which of the following bonds would most likely
be the highest?
A. First mortgage debt
B. Senior unsecured debt
C. Junior subordinate debt
5. During bankruptcy proceedings of a firm, the priority of claims was not strictly adhered
to. Which of the following is the least likely explanation for this outcome?
A. Senior creditors compromised.
B. e value of secured assets was less than the amount of the claims.
C. A judge’s order resulted in actual claims not adhering to strict priority of claims.
28 Part I: Learning Objectives, Summary Overview, and Problems
6. A fixed income analyst is least likely to conduct an independent analysis of credit risk
because credit rating agencies:
A. may at times mis-rate issues.
B. often lag the market in pricing credit risk.
C. cannot foresee future debt-financed acquisitions.
7. If goodwill makes up a large percentage of a company’s total assets, this most likely indi-
cates that:
A. the company has low free cash ow before dividends.
B. there is a low likelihood that the market price of the company’s common stock is
below book value.
C. a large percentage of the company’s assets are not of high quality.
8. In order to analyze the collateral of a company a credit analyst should assess the:
A. cash ows of the company.
B. soundness of management’s strategy.
C. value of the company’s assets in relation to the level of debt.
9. In order to determine the capacity of a company, it would be most appropriate to analyze
the:
A. company’s strategy.
B. growth prospects of the industry.
C. aggressiveness of the company’s accounting policies.
10. A credit analyst is evaluating the credit worthiness of three companies: a construction
company, a travel and tourism company, and a beverage company. Both the construc-
tion and travel and tourism companies are cyclical, whereas the beverage company is
non-cyclical. e construction company has the highest debt level of the three companies.
e highest credit risk is most likely exhibited by the:
A. construction company.
B. beverage company.
C. travel and tourism company.
11. Based on the information provided in Exhibit 1, the EBITDA interest coverage ratio of
Adidas AG is closest to:
A. 7.91x.
B. 10.12x.
C. 12.99x.
Chapter 5 Fundamentals of Credit Analysis 29
12. e following information is from the annual report of Adidas AG for December 2010:
• Depreciation and amortization: €249 million
• Total assets: €10,618 million
• Total debt: €1,613 million
• Shareholders’ equity: €4,616 million
e debt/capital ratio of Adidas AG is closest to:
A. 15.19%.
B. 25.90%.
C. 34.94%.
13. Funds from operations (FFO) of Pay Handle Ltd increased in 2011. In 2011 the total
debt of the company remained unchanged, while additional common shares were issued.
Pay Handle Ltd’s ability to service its debt in 2011, as compared to 2010, most likely:
A. improved.
B. worsened.
C. remained the same.
14. Based on the information in Exhibit 2, Grupa Zywiec SA’s credit risk is most likely:
A. lower than the industry.
B. higher than the industry.
15. Based on the information in Exhibit 3, the credit rating of Davide Campari-Milano S.p.A.
is most likely:
A. lower than Associated British Foods plc.
B. higher than Associated British Foods plc.
C. the same as Associated British Foods plc.
30 Part I: Learning Objectives, Summary Overview, and Problems
EXHIBIT 3 European Food, Beverage, and Tobacco Industry; Associated British Foods plc; and
Davide Campari-Milano S.p.A Selected Financial Ratios, 2010
Company
Total
Debt/Total
Capital
(%)
FFO/
Total
Debt (%)
Return on
Capital (%)
Total
Debt/
EBITDA
(x)
EBITDA
Interest
Coverage
(x)
Associated British Foods plc 0.2 84.3 0.1 1.0 13.9
Davide Campari-Milano S.p.A. 42.9 22.9 8.2 3.2 3.2
European Food, Beverage, and
Tobacco Median
42.4 23.6 6.55 2.85 6.45
16. Holding all other factors constant, the most likely effect of low demand and heavy new
issue supply on bond yield spreads is that yield spreads will:
A. widen.
B. tighten.
C. not be affected.