Agencies such as Moody’s, Fitch, and Standard & Poor's rate the default risk of various municipal...

Agencies such as Moody’s, Fitch, and Standard & Poor's rate the default risk of various municipal and corporate bonds. While their rating systems are proprietary, it is widely known that they rely on financial ratios as key inputs to their bond ratings. Which financial ratios (list at least two) do you believe would be the most helpful to rate corporate bonds? Why?

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Expert Solution

Some of the key ratios that are used by rating agencies to determine a corporate bond's rating are discussed below:

1. Profit Margin - the ratio of Profit after Tax and net operating Income is called Profit Margin

Profit Margin is a very good indicator of a company's performance in terms of its competitive position in its industry. It tells about a company's ability to tackle any business or financial risks. Hence this profitability ratio is used by rating agencies like moody's, Fitch, to rate a company's corporate bonds.

Profit Margin = Profit after Tax (PAT)/Net operating Income

2. Current Ratio - It is the ratio of a company's current assets to its current liabilities. It indicates a firm's ability to pay its short term debt and is thus an important indicator of the company's overall liquidity. Rating agencies often look at this ratio to evaluate the company's bonds rating.

Current ratio = Current Assets/Current Liabilities

jeff jeffy answered 1 year ago

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