Guide to Analysing Companies

C
92
CREDIT DEFAULT SWAP
01 Essential Finance 10/11/06 2:21 PM Page 92

---

Credit enhancement
A technique used by issuers of bonds to make it easier and
cheaper to raise debt. Companies issuing bonds in the debt
markets can ask banks to provide letters of credit to
support an issue, so raising their credit rating by a notch or
two. Municipal authorities can do the same by insuring an issue
of new bonds with a specialist agency such as America’s Mu-
nicipal Bond Investors’ Assurance. These agencies or banks
charge a fee in return for assuming part of the risk associated
with the issue. The effect is to reduce the rate of interest or
coupon paid to the holder of the bond. This is because a
buyer will generally think a higher credit rating reduces the risk
of a default (that is, of the issuer being unable to pay interest
or to repay the bond in full when it becomes due).
Credit insurance
Protection against the chance of abnormal losses from unpaid
accounts receivable (that is, amounts owed to a person or
company by creditors). Banks lending to a company against the
security of its accounts receivable will often insist on insur-
ance of this kind. Individuals with mortgages or large
amounts of consumer credit may also be asked to take out
similar cover to protect them against death or disability.
Credit line
A credit limit agreed between a customer and a bank which the
customer can draw upon as and when required.
Credit note
A written message informing a customer that his or her
account with a supplier has been credited (and by how much).
Credit notes are frequently used when a customer returns
C
CREDIT NOTE
93
01 Essential Finance 10/11/06 2:21 PM Page 93

---

goods as being below standard, or when there has been a
short shipment.
Credit rating
A formal assessment of a company’s creditworthiness, and of
its ability to meet payments on time. A credit rating is often ob-
tained by a trader dealing with a new customer for the first time.
It may come from a client’s bankers or from existing suppliers,
or from one of the specialist agencies (such as Dun & Bradstreet)
that provide such ratings for a fee. Agencies (such as Moody’s or
Standard & Poor’s) also assign formal credit ratings to the issuers
of bonds, be they governments, national or supranational
agencies, or companies. The higher the rating, the lower is the
risk of default. The highest (and therefore safest) rating is
usually AAA (triple A) and the lowest is D. Issuers that are
downgraded to junk are called fallen angels; those that
make the opposite journey are known as rising stars.