Factors Involved in the Assessment of Credit Default Risk - Dissertation Example

The most evident and significant measure to avoid credit risk is to examine the creditworthiness of the borrower. In carrying out such an assessment, credit analysts investigate or measure the factors that influence the business risk of a borrower. These factors are generalized into four basic categories, which are: • the quality of the borrower,• the potential of the borrower to fulfill the debt obligation, • the seniority level and the security provided in a bankruptcy proceeding, and • the constraints applied to the borrower.

The quality of the borrower, in the case of a corporation, includes the assessment of the business strategies and management policies of the firm. To be more specific, a credit analyst will examine the strategic plan, the financial philosophy, and the accounting control systems of the corporation in relation to the use of debt (Fabozzi, 2009). The potential of the borrower to fulfill its obligations starts with the assessment of the financial statements of the borrower. It is important to investigate and estimate the most frequently used measures of liquidity and debt coverage along with future cash flows, provided that there are some issues.

Moreover, the assessment considers the prime operating and competitive position of the borrower, the trends of the industry, the sources of liquidity or the backup option of a credit, and, if required, the regulatory environment. The study of the industry trends helps a credit analyst in analyzing the firm’s vulnerability towards the economic cycles, the entry barriers, as well as its exposure to technological changes. An analysis of the different lines of business of the borrower helps the credit analyst in evaluating the fundamental operating position of the firm.

A credit analyst will act as a creditor while examining the firm’s position in the case of bankruptcy.