CFA Level I · CFA Level I Exam · Credit Analysis for Corporate Issuers
Compared with a firm with stable, diversified cash flows, a firm with highly cyclical cash flows and the same debt-to-EBITDA ratio is most likely to be viewed by credit analysts as having:
The cyclical firm is most likely viewed as having higher credit risk, because its cash flows are less predictable and may fall sharply in downturns, threatening debt service even though leverage ratios match. Bondholders gain little from upside.
- Alower credit risk because of its higher potential upside
- Bhigher credit risk because its ability to service debt is less predictableCorrect
- Cequal credit risk because the leverage ratios are identical
Explanation
Credit analysis focuses on downside and the reliability of cash flows. Cyclical earnings can fall sharply in downturns, weakening coverage, so equal leverage implies greater risk. Upside does not benefit bondholders.
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