"Fixed Income Investments":the credit risk

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Questions 1:

A credit analyst observes the following information for Zeta Corp. and its industry.

	Zeta Corp.	Industry Median
Return on capital （%）	19.0%	20.0%
Total debt/Total capital （%）	42.0%	15.5%
FFO/Total debt （%）	45.3%	40.0%
Total debt/EBITDA （x）	3.5x	1.2x
EBITDA interest coverage （x）	4.0x	7.5x

Based on this information, it is most likely that the credit risk of Zeta Corp. is:

A. below its industry peers.

B. above its industry peers.

C. similar to its industry peers.

Questions 2:

Which of the following is least likely a component of yield spread?

A. Expected inflation rate

B. Taxation

C. Credit risk

View answer resolution

【Answer to question 1】（B）

【analysis】

While the company has a similar return on capital it has significantly higher leverage as well as lower EBITDA interest coverage ratio than its industry peers. It is likely that the company's credit risk will be above its industry peers.

【Answer to question 2】（A）

【analysis】

Building blocks of the yield curve are spread (risk premium) and a benchmark (risk-free rate of return). Expected inflation rate and expected real rate are components of the risk-free rate of return (i.e., the benchmark).

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