Credit Analysis Basics

Abstract

Capital markets facilitate the appropriate exchange of money. For lenders and borrowers, the interest rate is the primary pricing mechanism that markets use in this exchange. For borrowers deemed to have higher credit risk, lenders add a risk premium to the interest rate to compensate for higher risk. Credit risk is the risk that the borrower will default on (not pay) the payments agreed upon in the loan. Such risk-based interest rates ensure that money flows appropriately between lenders and borrowers.Credit analysis is the process of determining a potential borrower's credit risk. This note explores credit analysis and its relation to the credit-risk premium in interest rates.

Excerpt

UVA-F-1898

Mar. 9, 2020

Credit Analysis Basics

Capital markets facilitate the appropriate exchange of money. For lenders and borrowers, the interest rate is the primary pricing mechanism that markets use in this exchange. For borrowers deemed to have higher credit risk, lenders add a risk premium to the interest rate to compensate for higher risk. Credit risk is the risk that the borrower will default on (not pay) the payments agreed upon in the loan. Such risk-based interest rates ensure that money flows appropriately between lenders and borrowers.

Credit analysis is the process of determining a potential borrower's credit risk. This note explores credit analysis and its relation to the credit-risk premium in interest rates.

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Keywords: capital market, interest rates, credit risk, risk premium, credit analysis, Iceland, fishing, financial statement, income statement, financial modeling, loan, financing, five Cs, coverage ratio, debt-to-EBITDA ratio, bank loan, corporate bond, bond rating, investment bank, coupon rate, credit rating