Jerry Sanders, CFA, has been asked to analyze the 20-year bonds of Marietta Tech, Inc., which are currently being held in a corporate bond portfolio managed by a colleague, and to recommend whether the bonds should be sold or held. The bonds currently have a yield spread of 1.55% over Treasuries.Marietta Tech, Inc. designs, manufactures, and markets specialty trucks and truck bodies mounted on new truck chassis produced by others, including concrete mixers, refuse bodies, fire and emergency vehicles, defense trucks, cut-away and dry freight van bodies, refrigerated units, stake bodies, and other specialized trucks. Marietta also manufactures fiberglass wind deflectors, armored trucks, shuttle buses, and cargo vans. Marietta's customers are located in the United States and Canada.Exhibit 1: Selected Financial Data for Marietta Tech, Inc. (in thousands of $)At lunch Sanders discusses the credit analysis of various types of bonds with Elizabeth Yan, who was just hired as a bond analyst. Yan makes the following statements:Statement 1: An analysis of the issuer's business and operating risks is important to the analysis of corporate bond credit risk but not important for the credit analysis of asset backed securities (ABS).Statement 2: The unique bond covenants in a municipal bond's trust indenture require an additional level of credit analysis not necessary in a corporate credit analysis.After lunch Sanders asks Tatiana Petrovich in the municipal bond department for her opinion on the most important factors in the risk assessment of tax-backed municipal debt. Petrovich identifies three factors:1. A measure of debt burden, such as debt-per-capita in the tax jurisdiction.2. An evaluation of tax collection rates and intergovernmental revenue ability.3. Analysis of the municipality's budgetary policies as an indication of financial discipline.Compare the 2008 free CFO-to-long-term obligations ratio benchmarks to Marietta's ratio. Marietta is between the:
Answer(s): B
Marietta's free CFO-to-LT obligations ratio of 3.9% is between the BBB median (5.7%) and the BB median (3.4%).
Jerry Sanders, CFA, has been asked to analyze the 20-year bonds of Marietta Tech, Inc., which are currently being held in a corporate bond portfolio managed by a colleague, and to recommend whether the bonds should be sold or held. The bonds currently have a yield spread of 1.55% over Treasuries.Marietta Tech, Inc. designs, manufactures, and markets specialty trucks and truck bodies mounted on new truck chassis produced by others, including concrete mixers, refuse bodies, fire and emergency vehicles, defense trucks, cut-away and dry freight van bodies, refrigerated units, stake bodies, and other specialized trucks. Marietta also manufactures fiberglass wind deflectors, armored trucks, shuttle buses, and cargo vans. Marietta's customers are located in the United States and Canada.Exhibit 1: Selected Financial Data for Marietta Tech, Inc. (in thousands of $)At lunch Sanders discusses the credit analysis of various types of bonds with Elizabeth Yan, who was just hired as a bond analyst. Yan makes the following statements:Statement 1: An analysis of the issuer's business and operating risks is important to the analysis of corporate bond credit risk but not important for the credit analysis of asset backed securities (ABS).Statement 2: The unique bond covenants in a municipal bond's trust indenture require an additional level of credit analysis not necessary in a corporate credit analysis.Compare the 2008 long-term obligations to capitalization ratio benchmarks to Marietta's ratio. Marietta is between the:
Mariettas long-term obligations-to-capitalization ratio of 59.4% is between the BBB median (56.3%) and the BB median (68.5%).(Study Session 14, LOS 51.c)
Jerry Sanders, CFA, has been asked to analyze the 20-year bonds of Marietta Tech, Inc., which are currently being held in a corporate bond portfolio managed by a colleague, and to recommend whether the bonds should be sold or held. The bonds currently have a yield spread of 1.55% over Treasuries.Marietta Tech, Inc. designs, manufactures, and markets specialty trucks and truck bodies mounted on new truck chassis produced by others, including concrete mixers, refuse bodies, fire and emergency vehicles, defense trucks, cut-away and dry freight van bodies, refrigerated units, stake bodies, and other specialized trucks. Marietta also manufactures fiberglass wind deflectors, armored trucks, shuttle buses, and cargo vans. Marietta's customers are located in the United States and Canada.Exhibit 1: Selected Financial Data for Marietta Tech, Inc. (in thousands of $)At lunch Sanders discusses the credit analysis of various types of bonds with Elizabeth Yan, who was just hired as a bond analyst. Yan makes the following statements:Statement 1: An analysis of the issuer's business and operating risks is important to the analysis of corporate bond credit risk but not important for the credit analysis of asset backed securities (ABS).Statement 2: The unique bond covenants in a municipal bond's trust indenture require an additional level of credit analysis not necessary in a corporate credit analysis.Based on the available information, Sanders should:
First, compare Mariettas ratios to the median ratios:Marietta's EBITDA/interest (6.45) is between the A median (8.8) and the BBB median (5.5). Marietta's EBIT/interest (4.34) is between the A median (5.9) and the BBB median (3.2).Marietta's EBIT-to-sales ratio of 18.3% is between the A median (18.8%) and the BBB median (15-7%).Marietta's free CFO-to-LT obligations ratio of 3.9% is between the BBB median (5.7%) and the BB median (3.4%).Marietta's long-term obligations-to-capitalization ratio of 59.4% is between the BBB median (56.3%) and the BB median (68.5%).Next, compare Marietta's yield spread to 20-year yield spreads by bond rating: Marietta's yield spread of 1.55% is comparable to the average for A-rated bonds.Therefore, Sanders should recommend selling the Marietta bonds because the spread is comparable to A-rated bonds, but the ratios are more consistent with a BBB rating. (Study Session 14, LOS 51 - d)
Jerry Sanders, CFA, has been asked to analyze the 20-year bonds of Marietta Tech, Inc., which are currently being held in a corporate bond portfolio managed by a colleague, and to recommend whether the bonds should be sold or held. The bonds currently have a yield spread of 1.55% over Treasuries.Marietta Tech, Inc. designs, manufactures, and markets specialty trucks and truck bodies mounted on new truck chassis produced by others, including concrete mixers, refuse bodies, fire and emergency vehicles, defense trucks, cut-away and dry freight van bodies, refrigerated units, stake bodies, and other specialized trucks. Marietta also manufactures fiberglass wind deflectors, armored trucks, shuttle buses, and cargo vans. Marietta's customers are located in the United States and Canada.Exhibit 1: Selected Financial Data for Marietta Tech, Inc. (in thousands of $)At lunch Sanders discusses the credit analysis of various types of bonds with Elizabeth Yan, who was just hired as a bond analyst. Yan makes the following statements:Statement 1: An analysis of the issuer's business and operating risks is important to the analysis of corporate bond credit risk but not important for the credit analysis of asset backed securities (ABS).Statement 2: The unique bond covenants in a municipal bond's trust indenture require an additional level of credit analysis not necessary in a corporate credit analysis.Are Statement 1 and Statement 2 made by Yan correct?
Answer(s): A
Both of Yan's statements are correct. The two most important factors in an analysis of a corporate issuer are the capacity to pay (particularly a cash Bow analysis) and the corporate governance structure. This requires an analysis of the issuers business and operating risks {e.g. profitability, solvency, and leverage).However, there are no business or operating risks to assess with an ABS. Instead the emphasis is on the quality of the collateral that backs the ABS, particularly the collateral's capacity to generate cash flow to meet the repayment obligations of each tranche under various scenarios of default and delinquency experience.The analysis of municipal tax-backed and revenue bonds is simitar to that of corporate issuers. The only important difference in the analysis of municipal bonds is that the rate covenants and priority- of-revenue claims clause are unique to the trust indenture of municipal revenue bonds, so they require an additional level of analysis not necessary with corporate bonds. (Study Session 14, LOS 51.e,h,j)
Jerry Sanders, CFA, has been asked to analyze the 20-year bonds of Marietta Tech, Inc., which are currently being held in a corporate bond portfolio managed by a colleague, and to recommend whether the bonds should be sold or held. The bonds currently have a yield spread of 1.55% over Treasuries.Marietta Tech, Inc. designs, manufactures, and markets specialty trucks and truck bodies mounted on new truck chassis produced by others, including concrete mixers, refuse bodies, fire and emergency vehicles, defense trucks, cut-away and dry freight van bodies, refrigerated units, stake bodies, and other specialized trucks. Marietta also manufactures fiberglass wind deflectors, armored trucks, shuttle buses, and cargo vans. Marietta's customers are located in the United States and Canada.Exhibit 1: Selected Financial Data for Marietta Tech, Inc. (in thousands of $)At lunch Sanders discusses the credit analysis of various types of bonds with Elizabeth Yan, who was just hired as a bond analyst. Yan makes the following statements:Statement 1: An analysis of the issuer's business and operating risks is important to the analysis of corporate bond credit risk but not important for the credit analysis of asset backed securities (ABS).Statement 2: The unique bond covenants in a municipal bond's trust indenture require an additional level of credit analysis not necessary in a corporate credit analysis.In addition to the factors noted by Pctrovich, which of the following is likely to be the most important in the risk assessment of tax-backed municipal debt?
Answer(s): C
Choice C is most likely to best complement the other three factors Petrovich already mentioned. Choice A sounds reasonable, but it is very similar to factor (1) because both measure the municipality's debt burden, which means she already identified it. Covenants (as suggested in choice B) are important in the analysis of revenue bonds, not necessarily in the analysis of tax-backed bonds. (Study Session 14, LOS 51.h)(Study Session 14, LOS 54.d)
Post your Comments and Discuss CFA CFA-Level-II exam prep with other Community members:
Our website is free, but we have to fight against AI bots and content theft. We're sorry for the inconvenience caused by these security measures. You can access the rest of the CFA-Level-II content, but please register or login to continue.