Question

1. Explicate Professor ’s metrics of forecasting bankruptcy.

please answer in essay form

Answer 1

The Altman Z-score is a combination of five weighted business ratios that is used to estimate the likelihood of financial distress. If the credit crunch itself wasn't lesson enough, respected fund manager Anthony Bolton has emphasised the importance of understanding credit risk when investing in equities.

The Z-Score was developed in 1968 by Edward I. Altman, an Assistant Professor of Finance at New York University, as a quantitative balance-sheet method of determining a company's financial health. A Z-score can be calculated for all non-financial companies and the lower the score, the greater the risk of the company falling into financial distress.

Altman calculated 22 common financial ratios for all of them and then used multiple discriminant analysis to choose a small number of those ratios that could best distinguish between a bankrupt firm and a healthy one.

The results indicated that, if the Altman Z-Score is close to or below 3, it is wise to do some serious due diligence before considering investing. The Z-score results usually have the following quot;Zonesquot; of interpretation:

• Z Score below 2.99 -"Safe" Zones. The company is considered 'Safe' based on the financial figures only.
• 1.8 lt; Z lt; 2.99 -"Grey" Zones. There is a good chance of the company going bankrupt within the next 2 years of operations.
• Z below 1.80 -"Distress" Zones. The score indicates a high probability of distress within this time period.