CCP Credit Analysis & Risk Assessment 3

Question 1

A guarantor has a net worth of $500,000 but $450,000 is tied up in illiquid real estate. How should a credit analyst assess this guarantee?

Accepted Answer

The guarantee provides limited protection due to the illiquid nature of most assets

Answer

A guarantee backed primarily by illiquid assets offers limited practical protection since realizing value from real estate can be slow and uncertain during a credit event.

Question 2

What is the primary distinction between 'Probability of Default (PD)' and 'Expected Loss (EL)'?

Accepted Answer

PD measures likelihood of default alone; EL incorporates PD, LGD, and EAD together

Answer

PD is just the probability a borrower defaults; Expected Loss = PD × LGD × EAD, combining probability, severity, and exposure into one risk metric.

Question 3

A company reports strong net income but consistently negative operating cash flow. What is the MOST likely explanation?

Accepted Answer

Aggressive revenue recognition or working capital build-up consuming cash

Answer

Persistent divergence between net income and operating cash flow often indicates aggressive accrual accounting or excessive working capital growth that consumes cash.

Question 4

Which financial ratio is most directly used to assess whether a company can service its interest obligations from operating earnings?

Accepted Answer

Interest Coverage Ratio (EBIT / Interest Expense)

Answer

The Interest Coverage Ratio measures how many times operating earnings cover interest expense, directly indicating the company's ability to meet interest obligations.

Question 5

In assessing commercial real estate (CRE) loan risk, what does the Debt Service Coverage Ratio (DSCR) measure?

Accepted Answer

Net Operating Income divided by annual debt service, measuring cash flow sufficiency

Answer

DSCR = NOI / Annual Debt Service; a ratio above 1.0x means the property generates enough income to cover loan payments, with higher ratios indicating more cushion.

(CCP) Certified Credit Professional Practice Test

(CCP) Certified Credit Professional Practice Test

CCP Credit Analysis & Risk Assessment 3