Risk Management

• Credit risk is a business risk that a lender bears when a borrower fails to pay his obligations.
• Credit Information Systems is dedicated to providing the best credit reporting, appraisal management, and lending risk mitigation products with unequaled service.


  In the Philippines, RA No. 9510 was enacted in October 31, 2008 establishing the credit information system.
• Credit Ratings are driver of interest rate or risk consideration that affects the confidence of investors. These are determined by companies that are globally recognized that objectively assigns or evaluates countries and companies based on the riskiness of doing business with them.
• Standard and Poor's Corporation (S&P) was founded in 1941 by Henry Varnum Poor to assess credit worthiness of an industry.
• Moody's Investors Service was founded in 1909 is aimed to provide credit rating on debt securities.
• Fitch Ratings was founded in 1914 and owned by Hearst, provides credit opinions based on the credit expectations on certain quantitative and qualitative factors that drive a company.
• Expectation Theory states that are driven by the expectations of the lender or borrowers in the risk of the market in the future.


  • Pure Expectation Theory is based on statistical and current data analysis.
  • Biased Expectation Theory only considers factors that affect the term structure of the loan as well as the interest rates to be perceived.
• Market Segmentation Theory assumes that the driver of the interest are the saving and investment flows.
• BSP defines interest rates to be a type of price which will compensate the risk of allowing finances to flow into financial systems. For lenders - investment returns and For Borrowers - cost of debt.
• Cost of debt refers to the effective rate a company pays on its current debts. It also refers to the after-tax cost of debts.


  Cost of Debt = Interest Expense (1 - Tax Rate)
• Risk-Free Rate of Return is the theoretical rate of return of an investment with zero risk. This represents the interest an investor would expect from an absolutely risk free investment over a specified amount of time. 


  Risk-Free Rate of Return= Risk Free Rate - Inflation Rate
• Risk is a very important factor to consider that may drive the business up or down. It relates to the volatility patterns in the business.
• Default risks arises on the inability to make consistent payments. This type of risk may be quantified by determining the probability of the borrower to default in their payments in the duration of the loan.
• Liquidity risk focuses on the entire liquidity of a company or its ability to service its current portion of its debt as it becomes due.
• Legal risk will arise only upon the inability of any of the parties to comply with the covenants in the contract.
• Market risk is the impact of market drivers to the ability of the borrowers to settle the obligation. This is a classified as a systematic risk because it arises from external forces or based on the movement of the industry.
• Spot rates are interest rates that is available or applicable for a particular time. It may be used to mitigate the risk by referring to the historical yield vis-a-vis the forces that occur in those times.
• Forward rates are normally contracted rates that fixed the rates and allow the parties to assume such risk on the difference between the contracted rate and its spot rate.
• Swap rates are a contract rate where a fixed rate exchanges for a certain market at a certain maturity.
• Basis Points (BP) are unit of measurement equal to the 1/100th of 1 percent. They are used for measuring interest rates, the yield of a fixed income security, and other percentages or rates used in finance.
• Liquidity is more involved strategy than solvency due to it being a short-term measurement of business.
• The current ratio expresses the capability of current assets to cover its current liabilities without resorting to selling long-term assets to cover its current obligations.


  Formula: Current Assets / Current Liabilities
• The quick ratio is a higher liquidity ratio that uses quick assets that reveal a very liquid company in terms of financial health.


  Formula: Current Assets - Inventories & Prepayments / Current Liabilities
• Debt Ratio measures the business total liabilities as a percentage if its total assets. It is the ability to pay its liabilities with existing assets.


  Formula: Total Liabilities / Total Assets
• The Debt to Equity Ratio compares a business total debt to its total equity. A higher ratio means that the financing aspect of the business comes from creditors than from its owners.


  Formula: Total Liabilities / Total Equity
• Collaterals are normally required by financial institutions when acquiring large loans - the higher their values are, the bigger a loan can be with minimal interest rate.
• The Cost Approach values the asset by determining the cost to replace or reproduce this.
• The Market Approach states that an asset is worth as much as other assets with similar utility in the marketplace under this approach.
• Income Approach states that investors pay for the expected cash they will receive every year from an asset and when the asset is sold in the future.