Which of the following is used to assess a governments ability to pay its debts?
2023 Curriculum CFA Program Level I Fixed Income Show
IntroductionWith bonds outstanding worth many trillions of US dollars, the debt markets play a critical role in the global economy. Companies and governments raise capital in the debt market to fund current operations; buy equipment; build factories, roads, bridges, airports, and hospitals; acquire assets; and so on. By channeling savings into productive investments, the debt markets facilitate economic growth. Credit analysis has a crucial function in the debt capital markets—efficiently allocating capital by properly assessing credit risk, pricing it accordingly, and repricing it as risks change. How do fixed-income investors determine the riskiness of that debt, and how do they decide what they need to earn as compensation for that risk? In the sections that follow, we cover basic principles of credit analysis, which may be broadly defined as the process by which credit risk is evaluated. Readers will be introduced to the definition of credit risk, the interpretation of credit ratings, the four Cs of traditional credit analysis, and key financial measures and ratios used in credit analysis. We explain, among other things, how to compare bond issuer creditworthiness within a given industry as well as across industries and how credit risk is priced in the bond market. Our coverage focuses primarily on analysis of corporate debt; however, credit analysis of sovereign and nonsovereign, particularly municipal, government bonds will also be addressed. Structured finance, a segment of the debt markets that includes securities backed by such pools of assets as residential and commercial mortgages as well as other consumer loans, will not be covered here. We first introduce the key components of credit risk—default probability and loss severity— along with such credit-related risks as spread risk, credit migration risk, and liquidity risk. We then discuss the relationship between credit risk and the capital structure of the firm before turning attention to the role of credit rating agencies. We also explore the process of analyzing the credit risk of corporations and examine the impact of credit spreads on risk and return. Finally, we look at special considerations applicable to the analysis of (i) high-yield (low-quality) corporate bonds and (ii) government bonds. Learning OutcomesThe member should be able to:
SummaryIn this reading, we introduced readers to the basic principles of credit analysis. We described the importance of the credit markets and credit and credit-related risks. We discussed the role and importance of credit ratings and the methodology associated with assigning ratings, as well as the risks of relying on credit ratings. The reading covered the key components of credit analysis and the financial measure used to help assess creditworthiness. We also discussed risk versus return when investing in credit and how spread changes affect holding period returns. In addition, we addressed the special considerations to take into account when doing credit analysis of high-yield companies, sovereign borrowers, and non-sovereign government bonds.
Price impact ≈ –(MDur × ∆Spread) + ½Cvx × (∆Spread)2 Which of the following is used to assess a government's ability to pay its debt?The debt-to-GDP ratio is the metric comparing a country's public debt to its gross domestic product (GDP). By comparing what a country owes with what it produces, the debt-to-GDP ratio reliably indicates that particular country's ability to pay back its debts.
Which of the following measures the debt paying ability in the shortLiquidity ratios indicate a company's short-term debt-paying ability.
Which of the following should be used to evaluate a firm's ability to pay its current liabilities?Answer and Explanation: The correct answer is option b) current ratio. The current ratio is a liquidity ratio that measures the company's ability to pay its currently maturing obligations. It is calculated based on the quotient of total current assets and the total current liabilities.
What type of ratios measure a firm's ability to pay its debts and stay in business?The current ratio measures a company's ability to pay off its current liabilities (payable within one year) with its current assets such as cash, accounts receivable, and inventories. The higher the ratio, the better the company's liquidity position.
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