Cash Flow Analysis and Credit Risk
This chapter is focused on the needs of bankers, credit analysts and others involved in business or corporate lending and the management of credit exposures and credit risk.
Before reading this chapter it is assumed that the reader has read and digested the earlier chapters on summarising and evaluating cash flows in Jury’s Cash Flow Template format.
WHAT IS CREDIT RISK?
Credit risk is usually defined as the probability of default. Default is the failure by one party to pay cash due to another party at the time specified by some contract between them.
The contract may be related to financing activities such as lending, leasing, factoring or invoice discounting. Lending encompasses the provision of short-, medium- and long-term loans, such as overdrafts, syndicated loans and mortgages, the issuance of bonds, debentures, commercial paper, medium-term loans, convertible bonds and all other forms of debt.
Alternatively, the contract may be related to some form of trade activity such as the supply of goods or services (trade credit) or the supply of higher value capital goods with some sort of deferred payment arrangement (vendor financing, leasing, hire purchase, project financings).
Thirdly the contract may relate to some form of investing activity, such as investments in derivative financial instruments such as swaps, options or any other asset where a counterparty pays (or receives) periodic variable payments to (from) the seller of the derivative. ...