Fundamental Bond Analysis

[Studystuff]

Hi,

I was hoping someone could give me a hand with the fundamental bond analysis section of chapter 11.

I have no problem understanding the theory here its more so how its applied. From what I can gather there are two ways credit analysis will be applied - 1. By the private investor looking at potentially investing in the bonds and 2. A credit rating agency.

My main query is if section 2.1 through to 2.5 in chapter 11 relate to both of these parties? Or is section 2.1 to 2.4 inclusive just for private investors and 2.5 just for credit rating agency? Ive had a look at past papers but cant really figure out what section relates exactly to what. There seems to be a lot of overlap so Im wondering if theres something I am missing. I.e if a question came up about a rating agency or a private investor, what parts of these notes are relevant?

I am trying to avoid a situation where if a 3/4 mark question came up in the space and I had to rely on just giving all the here.

Thanks very much!!

 

[Colin McKee]

Hi, My feeling is that you should probably not think of these sections as just being for the two situations you describe (private investor investing, or credit rating agency analysing). These are certainly two situations where a credit analysis would be carried out, but there are also many others: a bank giving a loan to a small unrated company or an individual, institutions giving money to a company in the private debt market, ...
Sections 2.1 to 2.5 just give a summary of the things that MAY be considered in these situations. So for example, when a large company issues a bond on the stock market, investors rarely ask what it is being used for, because finance is not ringfenced in the corporate world. But if there is a large takeover, the "purpose" may become more important as it will change the nature of the company, and hence its risk. Bond investors rarely ask how a 10-year bond will be repaid at the end, and will simply assume that when 10 years are up, the company will have some method of refinancing it. If an individual asks for a large bank loan, the purpose will be important for the bank to consider. And the bank will certainly ask the individual how they intend to repay the loan.
Credit rating agencies are just entities that do this analysis for a living. This is useful when large institutions are faced with a bond market that is so large that they cannot staff a department to do a credit analysis on each investment. But essentially they are just doing the work that the lender would do themselves if they had the time and money. For large stock market loans it makes sense for the issuer to pay a rating agency to rate the bond, as it may attract many institutions who would not otherwise invest (because they dont have the time to analyse the issue themselves). For a small bond, the cost of the rating would probably not be justified by the extra investor interest.

 

[Studystuff]

Hi Colin,

Thanks for these replies! That makes sense that these sections are a broad style summary of what would be relevant for credit analysis. If something comes up in the exam in this space I will draw on info from 2.1 to 2.5 and tailor it to the appropriate situation (like the examples you have highlighted). Thanks again!