CFA Practice Question

There are 534 practice questions for this study session.

CFA Practice Question

If you are a bondholder for a firm, which of the following ratios would you be most interested in?

I. Times interest earned
II. Total debt to total assets
III. Return on equity
IV. Quick ratio
A. I and II
B. I, II and IV
C. II and III
Explanation: Bondholders are interested in the debt utilization ratios, which in this case are times interest earned and total debt to total assets.

User Contributed Comments 18

User Comment
geet If I was a bondholder I would want to know the Quick ratio as well. It would tell you if the company could liquidate in case of bankruptcy and therefor pay you the bondholder.
Cata agree to geet; moreover, quick ratio tells you if the company face the risk of bankrupcy due to low liquidity, even if the firm is profitable!
haarlemmer Quick ratio does not contain interest payment. Thus directly it does not relate to the concerns of bondholders.
wollogo Disagree with haarlemmer and agree with the rest. Quick ratio effectively gives you the split between short-term and long-term debt and is highly relevant to the stability of the company. For example if you had a company with 50% debt all of which was short term debt then of course the liqudity ratios are important.
fedor5 quick ratio indicates if a firm is able to meet its current liabilities (which is bond interest payment too). so if a quick ratio is low then there is a probability that interst payment will not be made timely.
lovemehard If I were a bondholder I would be interested whether ROE is a positive....
chamad Roe is usefull for stockholders, Q
copus I would also be interested in the quick ratio, as fedor5 so wisely put it: it goes to the ability of the company to make interest payments.
mrdjb Long-term debt-holders are interested in solvency.
Short-term debt-holders are interested in liquidity.
jpducros mrdjb, I think you just won the debate !
meeravenk Yeah mrdjb cleared it up good!
hvanwyk There is no long term if you are unable to pay your creditors in the short term.
maria15 I agree with jpducros. For me, mrdjb just won the debate :)
Downgrade Yes. Bondholders wouldn't actively choose not to care about any of these. RoE is still important and can be decomposed into interest burden, so if you agree times interest earned is important, by extension you agree that RoE is important.
jnptrsn1 mrdjb, now you're thinking like a banker
ascruggs92 I guess bondholders wouldn't care about the quick ratio because, truth is, the company won't go bankrupt if they don't pay their suppliers, but it will if they don't pay the bank, so interest payments will take precedent.

Downgrade, if you can decompose ROE into interest burden, why use ROE in the first place and just look right at the interst burden?

ROE is not important to bondholders, and can actually be misleading. For example: Company A has a ROE of 10%, Company B has a ROE of 25%. Does this mean that company B is more credit worthy or at less risk of bankruptcy?

Nope. Company B could be heavily in debt and therefore have very low shareholders equity, Company A may have no debt and very high shareholders equity. It could be the case that Company A has higher net income than company B, but equity for B is so low that it yields a better return number.

So for bondholders, it is useless to look at that number. Instead of decomposing ROE through DuPont, you could just directly analyze other ratios. Remember they aren't taking a test when doing this so all the info they need is available
kingirm I would definitely be interested in the quick ratio of this firm if I were a bondholder. How much has this firm has cash ? You wouldn't ask ??
litlStar I am a senior credit analyst and we look at short-term liquidity (i.e. measures like the quick ratio).
You need to log in first to add your comment.