Showing papers on "Credit risk published in 1984"

A Pure Financial Explanation for Trade Credit

Abstract: This paper provided a pure financial explanation for the existence of trade credit and for the values of the credit terms offered to customers. Two motives for extending trade credit were identified. The pure operating flexibility motive arises because the opportunity to change credit policy provides the seller an efficient way to respond to fluctuations in demand. This motive was eliminated from consideration in this paper by assuming constant demand. The seller must hold a liquid reserve when the financial markets are imperfect and the desire to earn an excess rate of return on this reserve explains the pure financial intermediary motive for trade credit.The pure financial incentive to lend this liquid reserve to customers was examined by viewing a market borrowing rate of interest that exceeds the market lending rate of interest as a hindrance to trade or, equivalently, as a financial market tariff. This tariff imposes a wedge between the market prices paid and received for the product plus a loan and thereby inflicts a loss of surplus on the seller and buyers. Trade credit lending enables the seller and/or the buyers to recapture at least part of this loss when the source of the tariff does not apply to direct loans to customers. Financial market tariffs caused by transactions costs fulfill this requirement because the trade credit lender's familiarity with its customers and product provide it with information and collection cost advantages over financial intermediaries. Tariffs caused by financial intermediary rents fulfill this requirement as well because the parties to a trade credit loan do not employ the services of a financial intermediary.Increasing opportunity costs and financial market imperfections in addition to the ones described above establish the limits of credit policy. The optimal amount of accounts receivable is derived from the condition that the marginal revenue of trade credit lending is equal to the marginal cost. This condition combined with factoring costs produces a unique, finite optimal credit period. Accrual accounting for income tax purposes imposes an additional restriction because the firm is taxed on the recovery of its opportunity costs. These limitations on credit policy were examined separately in this paper for clarity but they are in effect simultaneously in practice.

Asymmetries of Information and LDC Borrowing with Sovereign Risk

Abstract: The dramatic rise in the amount and extent of private lending to the lessdeveloped countries following I973 has received widespread attention. During the current recession, the Western press has often reported that creditors were unaware of the total amount of lending to individual LDCs, thereby incorrectly assessing the risk of default. This paper presents a theoretical model of international lending with sovereign risk which emphasises the role of asymmetric information about total debt-service obligations between creditors and debtors. The model is used to explain how sovereign risk leads to important special features observed in LDC borrowing. The characteristics of borrowing by the LDCs on international capital markets have been investigated and described in several recent studies (see, for example, Eaton and Gersovitz (I98I b); Fleming (I98I); Hope (I98I); IMF (I98I and I980); O'Brien (1 98 I) and Wellens (I 977)). Eaton and Gersovitz (1 98 I b), in particular, argue that the threat of possible repudiation of debt by a sovereign country is responsible for the salient differences between market outcomes for LDC borrowing and the nature of loan contracts observed in lending between developed nations and in domestic corporate finance. Access to long-term loans on the Eurobond market is limited to very few non-OPEC LDCs, and most LDCs which receive loans on the private credit market obtain medium-term commercial credit from the major U.S. and European banks. Therefore, LD C debt is typically of shorter maturity than most developed country corporate debt. The lowest income LDCs almost never gain access to the private loan market and rely upon long-term borrowing from official creditors and international agencies. Private creditors are also reported to analyse individual countries' credit-worthiness, that is, their ability, or proclivity, to absorb capital inflows and repay debts. Therefore, the adoption of policies intended to signal credit-worthiness by LDC governments is often observed. Credit on international markets is typically quantity-rationed, with countries having higher rates of saving and investment receiving larger loans at lower rates of interest. Because lenders are often unable to obtain legal remedies for breach of contract in a debtor's political jurisdiction, mutually advantageous contracts common in domestic corporate bond-finance are unenforceable in the international credit market. In the presence of sovereign risk, lenders must rely upon the threatened denial of future credits and the disruption of a debtor's commodity trade or access to trade-finance to discourage the repudiation of debt. In the case of corporate finance, bond convenants and bankruptcy provisions protect creditors from increases in their exposure to default risk created by subsequent borrowing

The Informational Content of Bond Ratings

Abstract: This paper explores the risk structure of interest rates. More specifically, we ask whether yields on industrial and commercial bonds indicate that market participants base their evaluations of a bond issue's default risk on agency ratings or on publically available financial statistics. Using a non-linear least squares procedure, we relate the yield to maturity to Moody's rating, Standard & Poor's rating, and accounting measures of credit worthiness such as coverage and leverage. We find that market yields are significantly correlated with both the ratings and with a set of readily available financial accounting statistics. These results indicate (1) that market participants base their evaluations of an issue's credit worthiness on more than the agencies' ratings and (2) that the ratings bring some information to the market above and beyond that contained in the set of accounting variables. In addition, our results suggest that the market views Moody's and S&P's ratings as equally reliable measures of risk. Although the accounting measures also affect yields on new or recently reviewed issues, our analysis suggests that the market may pay more attention to the accounting measures and less to the ratings if the rating has not been reviewed recently.

Mineral Leasing Policy: Competitive Bidding and the Resource Rent Tax Given Various Responses to Risk*

Abstract: This paper considers the choice between lump-sum bidding and a tax conditional on net present value (of which the Resource Rent Tax is a practical example) as methods of collecting rent from mining projects. It demonstrates that there is an optimal combination of the two methods and that the relative emphasis to be placed on each depends heavily on the manner in which investors take risk into account. Four stylized ways in which investors and governments respond to risk are examined and, in addition to the more familiar types of risk, sovereign risk is introduced. The paper argues for the placing of relatively heavy emphasis on the conditional tax.

Credit Investigation Policy and Management Planning

Abstract: The selection of the optimal credit investigation policy is a sequential decision problem that Mehta solved using decision tree analysis. This paper explores the managerial implications of the credit investigation/credit granting policy. The credit policy selected effects the resources required for credit investigation, the scale of collection efforts, the level and breakdown of accounts receivable, cash budgets, and total sales and production costs.