Investment Portfolio

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FINAL PROJECT

Submitted to: MA’AM Attiya

Submitted by: Hina Arif

Major: M.Phil , Accounting & Finance

Semester: 03

Quantifying Risk in the Corporate Bond Market of Pakistan

INTRODUCTION

When credit-rating agencies evaluate the credit quality of a given debtor or debt issue, the market accepts their rating as qualified opinion on the likelihood of receiving timely payments of principal and interest in accordance with terms of the obligation. In Pakistan, PACRA – Pakistan Credit Rating Agency facilitates with its services. The credit ratings segment the credit-quality spectrum into universally accepted and well-defined categories, and thus, credit-rating agencies provide a valuable service to the financial market place.

Although credit rating agencies have distinct rating scales and definitions, the generic rating scale used throughout this article is AAA, AA, A, BBB, BB, B (credit-quality spectrum). This scale mirrors the scales of major rating agencies and covers the range in credit quality from gilt-edged to highly speculative. Credit ratings, however, do not quantify risk. In other words, one can state that the likelihood of default on a BBB-rated security is greater than the likelihood of default on an AA-rated security.

This article details a methodology for quantifying relative risk in the corporate bond market. The analysis involved calculating the historical volatility of corporate bond yield spreads as a function of credit rating and then quantifying the relative results. Furthermore, comparative results can be calculated across the whole credit-quality spectrum.

The EBITDA-interest coverage ratio was found to be highly correlated to the market’s assessment of risk across all rating categories. The EBITDA interest coverage ratio is dynamic ratio that incorporates the effects of both business risk and financial risk. Accordingly, it is a key component of the market’s pricing...