13 - Case studies on credit quality

Abstract

This chapter discusses numerous case studies on credit quality. The case study on the bankruptcy of a financial institution—Penn Square—is a lesson on how financial staying power disappears when management is no longer in control. Not only credit institutions fade away but also the financial centers of gravity change. Furthermore, there are different ways to compute the price impact of a rating change. The most popular is to multiply the change in yield between initial and new rating by the modified duration of the bond that expresses the percentage change in price associated with a 100 basis point move in interest rates. Marking to market by observing price changes of a statistically significant sample of bonds of different rating classes is another approach that helps in analyzing price impact of the issuer's change in rating. One could also use information on rate impact when the independent rating agency first placed the issue (or entity behind it) in its watch list.