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Structured Credit Products: Credit Derivatives and Synthetic Securitisation, 2nd Edition by Moorad Choudhry

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CHAPTER 4

Credit Analysis and Relative Value Measurement

Credit analysis is concerned with issuer-specific considerations (as opposed to macro considerations). This will include a quantitative analysis and a qualitative analysis that results in the assignment of an internal credit rating. Investors sometimes substitute the credit rating given by a third-party company such as Moody’s or S&P. The qualitative factors to consider include those both internal and exogenous to the company.

In this chapter, we consider the process of credit analysis, as this is important for investors to be familiar with. We then look at measuring credit relative value.

CREDIT ANALYSIS

When ratings agencies were first set up the primary focus of credit analysis was on the default risk of the bond, or the probability that the investor would not receive the interest payments and the principal repayment as they fell due. Although this is still important, credit analysts now also consider overall macroeconomic conditions, as well as the chance that an issuer will have its rating changed during the life of the bond. There are differences in approach, depending on which industry or market sector the issuing company is part of.

In this section we review the main issues of concern to a credit analyst when rating bond issues. Analysts usually adopt a ‘top-down’ approach, or a ‘big picture’ approach, and concentrate on the macro issues first before looking at the issuer-specific points in detail. The process therefore ...

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