Question

write 150 words Please discuss these topics; include the demand and supply of the credit, chance of default, financial ratios covering solvency and liquidity, the importance of credit ratings and bankruptcy prediction model (Altman's Z score). Your discussion should include, among others, the importance of credits in the capital market, the significance of crediting ratings for your long-term viability.

Answer 1

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Importance of credit in capital markets

1.Credit markets helps market participants issue new debt. This is usually done by the issue of bonds.

2.It increases liquidity.

3.It facilitates making payments in the capital market.

4.It helps to protect against risks.

Significance of crediting ratings:

It helps investors understand the credit worthiness of a company.
High credit rating provides assurance about the safety of money and that it will be paid back on time.

Financial institutions will use the credit rating for their lending activities.

It helps companies having a high credit score to obtain funding at a low cost of capital.

Companies will good credit rating can use it as a marketing tool to create a positive image in the mind of its customers.

It creates transparency in the financial market and reduces uncertainty.

Demand and supply of credit

Those who supply financial capital expect to receive a rate of return and those who demand financial capital are expected to pay a rate of return. This rate of return is called the interest rate.

The laws of demand and supply apply to financial markets as well. According to the law of demand, the higher the demand interest rate, lower will be the demand for financial capital. According to the law of supply, an increase in interest rate will increase the supply of financial capital.

Chance of default

Chance of default is a term describing the likelihood of default over a time period. It measures the probability than the borrower will be unable to meet his/her financial obligations. It is a concept used widely in credit analysis.

Liquidity Ratio

Liquidity Ratios are used to measures a company’s ability to pay its short term obligations.

Current ratio

Current ratio measures the ability of a company to pay its short-term obligations. It is calculated as current assets divided by current liabilities.

Current ratio= current assets/current liabilities

Quick ratio

Quick ratio is more stringent measure of liquidity. It does not include inventory and other assets that are not liquid

Quick ratio= cash+ marketable securities+ receivables/current liabilities

Cash ratio

Cash ratio is a conservative liquidity measure.

Cash ratio=cash+ marketable securities/current liabilities

Solvency ratio

Solvency ratio measures a company’s ability to meet its long-term obligations.

Debt to equity ratio

It measures the company’s use of fixed cost financing sources.

Debt to equity ratio=Total debt/Total shareholders equity

Debt to capital ratio

Debt to capital ratio measures the use of debt in a company’s capital structure.

Debt to capital ratio= total debt/total debt+ Total shareholders equity

Financial leverage

Financial leverage measures the use of debt financing.

Financial leverage= total average assets/Total average equity

Interest coverage ratio

Interest coverage ratio measures the company’s ability to repay its debts.

Interest coverage ratio= Earnings bedore interest and taxes/ Interest payments.

Altman's Z score

Altman's Z score is a credit strength test to measure a publicly traded company’s chances of bankruptcy. It determines how likely a company is to fail. The lower the score, higher is the probability of the company to declare bankruptcy.