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what are examples of covenants | covenants may be related to finances property law or religion in business a loan covenant may disallow a company from acquiring another company or may require a certain amount of cash on hand a property covenant may require the grass to be cut a specific number of times per year a religious covenant may be a promise from god to never send a destructive flood like the one noah experienced again | |
what do covenants on a property mean | covenants on a property restrict how a property can be used or set the precedence of how it must be used consider a house under the provision of a homeowner s association the hoa may restrict the owner from renting out the property or listing the property on airbnb | |
what is an example of covenants in real estate | real estate covenants used to restrict who could legally purchase or occupy real property for example consider covenants in king county seattle that used to enforce restrictions based on race national origin or ethnic background 5today real estate covenants are more related to the actual operation and maintenance of a home some covenants require certain action to be taken e g owners of a home must trim their trees while others restrict action e g owners of a home are not allowed to build a fence | |
what are the covenants in a contract | a contract can outline any covenant one party wishes to require as long as the other party agrees to its compliance as part of the contracting stage the two parties must communicate their requirements and negotiate what to include and exclude in a contract the covenants listed from one contract to another may be entirely different as different parties may wish to be protected in different ways | |
what is the lord s covenant | according to the bible the lord has made several covenants at the highest level god has promised to humanity that he will one day return to earth and grant everlasting life the bible also outlines several other covenants where god has made a promise to mankind that may or may not require action on humanity s part the bottom linecovenants create the parameters of many contracts whether it s the social contract enforced by a system of laws the boundaries created by a religion or limits on how to use your business or property read and understand any affirmative or negative covenants before entering into an agreement | |
what is a cover letter | a cover letter is a written document commonly submitted with a job application outlining the applicant s credentials and interest in the open position since a cover letter is often one of only two documents sent to a potential employer a well or poorly written letter can impact whether the applicant is called for an interview investopedia joules garciaunderstanding cover lettersmost job postings are done online and no longer require a physical application instead applicants send companies a copy of their resume along with a cover letter either by email or with a hard copy through the mail a resume offers a glimpse into the professional and academic experience of a potential employee the cover letter on the other hand acts as an introduction written by the candidate to express their interest in the position and what makes them the best fit for the job 1a good cover letter complements a resume by expanding on items relevant to the job 2 in essence it s a sales pitch that describes why the applicant is the best person for the position career experts advise job seekers to spend time customizing each cover letter for the particular position rather than using a generic missive although this requires extra effort it can be very helpful in allowing an applicant to stand out above the competition the cover letter provides information to the employer about who the candidate is as a professional and as a person this includes their areas of interest professional goals knowledge skills they ve gained over the years achievements passions and aspirations the cover letter should be a one page document that provides a clear and concise idea about why the candidate is the best person for the job it should also highlight the cultural fit 2types of cover letterswhile there is no set template for a cover letter the type of letter that you write will depend on the requirements of each individual company or employer the information that is included in a cover letter will vary depending on the goals and purpose of your application | |
when employers post a job ad that requires a cover letter they may specify certain requirements for the cover letter to address for example they may require applicants to answer certain questions or to respect a certain word limit it is important to follow these requirements as they reflect on the applicant s ability to understand and follow directions | if the employer does not set any expectations a typical cover letter should be about a page or less and may include a formal greeting contact information and links to the applicant s portfolio or work it should highlight any special skills and explain why you would be a good fit for the position this is your chance to impress the employer even if your resume does not have everything an employer wants a well written cover letter can make the applicant stand out from the crowd 4however it is possible to include too much information most employers will simply glance at the majority of their cover letters and a long winded essay might end up at the bottom of the pile a few short paragraphs explaining your skills and why you chose that specific employer should be enough to put your best foot forward 4tips for writing a cover letterwriting a cover letter doesn t have to be tedious even though it may seem like it s a chore here are a few simple tips you may want to consider when composing your cover letter a simple focused cover letter without any typos or grammatical errors will get you noticed by potential employers a perfect resume can often be sabotaged by a poorly thought out cover letter or one that is laden with mistakes whether you include the letter as per required submission guidelines or you simply want to emphasize your interest in the job make sure you avoid making these blunders | |
how long should a cover letter be | according to indeed a leading job seeking site a typical cover letter should be about three or four paragraphs long and highlight any special experience or achievements that make the applicant exceptionally well suited to the position 4 | |
how do you start a cover letter | a cover letter should start with a formal greeting preferably addressed to the hiring manager if you do not know who will be reading your cover letter a generic to whom it may concern is an acceptable albeit old fashioned way to address a cover letter it is also acceptable to address the letter to a title such as dear hiring manager or dear talent acquisition team 5 | |
what should a cover letter contain | an effective cover letter should highlight the applicant s skills experience and any achievements that make them a good fit for their prospective employer it is also a good chance to mention anything that is not included in the resume for example if an applicant is drawn to a certain employer because they love a certain product the cover letter is a great place to mention it make sure your cover letter also includes your name and contact information the bottom linein a competitive jobs market an effective cover letter is one way to make a job application stand out this is a chance for an applicant to demonstrate why they think they would be a good fit however a poorly written or meandering cover letter can hurt an application more than it helps | |
what is a coverage ratio | a coverage ratio broadly is a metric intended to measure a company s ability to service its debt and meet its financial obligations such as interest payments or dividends the higher the coverage ratio the easier it should be to make interest payments on its debt or pay dividends the trend of coverage ratios over time is also studied by analysts and investors to ascertain the change in a company s financial position investopedia julie bangunderstanding a coverage ratiocoverage ratios come in several forms and can be used to help identify companies in a potentially troubled financial situation though low ratios are not necessarily an indication that a company is in financial difficulty many factors go into determining these ratios and a deeper dive into a company s financial statements is often recommended to ascertain a business s health net income interest expense debt outstanding and total assets are just a few examples of financial statement items that should be examined to ascertain whether the company is still a going concern one should look at liquidity and solvency ratios which assess a company s ability to pay short term debt i e convert assets into cash investors can use coverage ratios in one of two ways first they can track changes in the company s debt situation over time in cases where the debt service coverage ratio is barely within the acceptable range it may be a good idea to look at the company s recent history if the ratio has been gradually declining it may only be a matter of time before it falls below the recommended figure coverage ratios are also valuable when looking at a company in relation to its competitors evaluating similar businesses is imperative because a coverage ratio that s acceptable in one industry may be considered risky in another field if the business you re evaluating seems out of step with major competitors it s often a red flag while comparing the coverage ratios of companies in the same industry or sector can provide valuable insights into their relative financial positions doing so across companies in different sectors is not as useful since it might be like comparing apples to oranges common coverage ratios include the interest coverage ratio debt service coverage ratio and asset coverage ratio these coverage ratios are summarized below types of coverage ratiosthe interest coverage ratio measures the ability of a company to pay the interest expense on its debt the ratio also known as the times interest earned ratio is defined as interest coverage ratio ebit interest expense | |
where | ebit earnings before interest and taxesan interest coverage ratio of two or higher is generally considered satisfactory the debt service coverage ratio dscr measures how well a company is able to pay its entire debt service debt service includes all principal and interest payments due to be made in the near term the ratio is defined as dscr net operating income total debt servicea ratio of one or above is indicative that a company generates sufficient earnings to completely cover its debt obligations the asset coverage ratio is similar in nature to the debt service coverage ratio but looks at balance sheet assets instead of comparing income to debt levels the ratio is defined as asset coverage ratio total assets short term liabilities total debt | |
where | total assets tangibles such as land buildings machinery and inventoryas a rule of thumb utilities should have an asset coverage ratio of at least 1 5 and industrial companies should have an asset coverage ratio of at least 2 other coverage ratiosseveral other coverage ratios are also used by analysts though they are not as prominent as the above three examples of coverage ratiosto see the potential difference between coverage ratios let s look at a fictional company cedar valley brewing the company generates a quarterly profit of 200 000 ebit is 300 000 and interest payments on its debt are 50 000 because cedar valley did much of its borrowing during a period of low interest rates its interest coverage ratio looks extremely favorable interest coverage ratio 3 0 0 0 0 0 5 0 0 0 0 6 0 begin aligned text interest coverage ratio frac 300 000 50 000 6 0 end aligned interest coverage ratio 50 000 300 000 6 0 the debt service coverage ratio however reflects a significant principal amount the company pays each quarter totaling 140 000 the resulting figure of 1 05 leaves little room for error if the company s sales take an unexpected hit dscr 2 0 0 0 0 0 1 9 0 0 0 0 1 0 5 begin aligned text dscr frac 200 000 190 000 1 05 end aligned dscr 190 000 200 000 1 05 even though the company is generating a positive cash flow it looks riskier from a debt perspective once debt service coverage is taken into account | |
the term covered call refers to a financial transaction in which the investor selling call options owns an equivalent amount of the underlying security to execute this an investor who holds a long position in an asset then writes sells call options on that same asset to generate an income stream the investor s long position in the asset is the cover because it means the seller can deliver the shares if the buyer of the call option chooses to exercise | investopedia alex dos diazunderstanding covered callscovered calls are a neutral strategy meaning the investor only expects a minor increase or decrease in the underlying stock price for the life of the written call option this strategy is often employed when an investor has a short term neutral view of the asset and for this reason holds the asset long and simultaneously has a short position via the option to generate income from the option premium 1simply put if an investor intends to hold the underlying stock for a long time but does not expect an appreciable price increase in the near term then they can generate income premiums for their account while they wait out the lull a covered call serves as a short term hedge on a long stock position and allows investors to earn income via the premium received for writing the option however the investor forfeits stock gains if the price moves above the option s strike price they are also obligated to provide 100 shares at the strike price for each contract written if the buyer chooses to exercise the option 2maximum profit and maximum lossthe maximum profit of a covered call is equivalent to the premium received for the options sold plus the potential upside in the stock between the current price and the strike price thus if the call is written with a strike price of 100 on a stock trading at 90 and the writer receives a premium of 1 00 per stock the maximum potential profit per stock is the 1 00 premium plus a 10 appreciation of the stock or a total of 1100 the maximum loss on the other hand is equivalent to the purchase price of the underlying stock less the premium received this is because the stock could potentially drop to zero in which case all you would receive is the premium for the options sold 1if the investor simultaneously buys a stock and writes call options against that position it is known as a buy write transaction advantages and disadvantages of covered callsan options writer can earn money by selling a covered call but they lose the potential profits if the call goes into the money however the writer must be able to produce 100 shares for each contract if the call expires in the money if they do not have enough shares they must buy them on the open market causing them to lose even more money covering calls can limit the maximum losses from an options transaction but it also limits the possible profits this makes them a useful strategy for institutional funds and traders because it allows them to quantify their maximum losses before entering into a position a covered call strategy isn t useful for very bullish or very bearish investors 3 very bullish investors are typically better off not writing the option and just holding the stock the option caps the profit on the stock which could reduce the overall profit of the trade if the stock price spikes covered options limit the risks and potential downsides of an options contract options writers can earn a reliable premium from a small price increase options writers must be able to produce 100 shares for each call option that expires in the money if an investor is very bullish on a security they can make more money from uncovered calls or buying the underlying security | |
when to use and when to avoid covered calls | the best time to sell covered calls is when the underlying security has neutral to optimistic long term prospects with little likelihood of either large gains or large losses this allows the call writer to earn a reliable profit from the premium covered calls are not an optimal strategy if the underlying security has a high chance of large price swings if the price rises higher than expected the call writer would miss out on any profits above the strike price if the price falls the options writer could stand to lose the entire price of the security minus the initial premium example of a covered calllet s say an investor owns shares of a hypothetical company called tsj although the investor likes its long term prospects and its share price they feel the stock will likely trade relatively flat in the shorter term perhaps within a couple of dollars of its current price of 25 if they sell a call option on tsj with a strike price of 27 they earn the premium from the option sale but for the duration of the option cap their upside on the stock to 27 assume the premium they receive for writing a three month call option is 0 75 75 per contract or 100 shares one of two scenarios will play out | |
are covered calls a profitable strategy | as with any trading strategy covered calls may or may not be profitable the highest payoff from a covered call occurs if the stock price rises to the strike price of the call that has been sold and is no higher the investor benefits from a modest rise in the stock and collects the full premium of the option as it expires worthless like any strategy covered call writing has advantages and disadvantages if used with the right stock covered calls can be a great way to reduce your average cost or generate income | |
are covered calls risky | covered calls are considered relatively low risk covered calls however would limit any further upside profit potential if the stock continued to rise and would not protect much from a drop in the stock price 3 note that unlike covered calls call sellers that do not own an equivalent amount in the underlying shares are naked call writers naked short calls have theoretically unlimited loss potential if the underlying security rises 4can i use covered calls in my ira depending on the custodian of your ira and your eligibility to trade options with them yes there are also certain advantages to using covered calls in an ira the possibility of triggering a reportable capital gain makes covered call writing a good strategy for either a traditional or roth ira investors can buy back the stock at an appropriate price without having to worry about tax consequences as well as generate additional income that can either be taken as distributions or reinvested | |
is there such a thing as a covered put | in contrast to call options put options grant the contract holder the right to sell the underlying as opposed to the right to buy it at a set price 5 the equivalent position using puts would involve selling short shares and then selling a downside put this however is uncommon instead traders may employ a married put where an investor holding a long position in a stock purchases a put option on the same stock to protect against depreciation in the stock s price the bottom linea covered call is an options trading strategy that allows an investor to profit from anticipated price rises to make a covered call the call writer offers to sell some of their securities at a pre arranged price sometime in the future this strategy offers lower upsides than other options strategies but also offers lower risk correction june 18 2024 this article has been corrected to state the maximum potential profit of a covered call in the example above | |
what is covered interest rate parity | covered interest rate parity refers to a theoretical condition in which the relationship between interest rates and the spot and forward currency values of two countries are in equilibrium the covered interest rate parity situation means there is no opportunity for arbitrage using forward contracts which often exists between countries with different interest rates covered interest rate parity cip can be compared with uncovered interest rate parity uip formula for covered interest rate paritythe formula for cirp is most commonly expressed as follows to determine the forward foreign exchange rate 1f s 1 id 1 if where f the forward foreign exchange rates the current spot exchange rateid the interest rate in the domestic currency or the base currencyif the interest rate in the foreign currency or the quoted currency begin aligned f s times frac 1 i d 1 i f textbf where f text the forward foreign exchange rate s text the current spot exchange rate i d text the interest rate in the domestic currency qquad text or the base currency i f text the interest rate in the foreign currency qquad text or the quoted currency end aligned f s 1 if 1 id where f the forward foreign exchange rates the current spot exchange rateid the interest rate in the domestic currency or the base currencyif the interest rate in the foreign currency or the quoted currency under normal circumstances a currency that offers lower interest rates tends to trade at a forward foreign exchange rate premium in relation to another currency offering higher interest rates there are several different ways to calculate the forward foreign exchange rate but the most common method is used here | |
what does covered interest rate parity tell you | covered interest rate parity is a no arbitrage condition that could be used in the foreign exchange markets to determine the forward foreign exchange rate the condition also states that investors could hedge foreign exchange risk or unforeseen fluctuations in exchange rates with forward contracts consequently the foreign exchange risk is said to be covered interest rate parity may occur for a period but that does not mean it will remain because interest rates and currency rates change over time example of how to use covered interest rate parityas an example assume country x s currency is trading at par with country z s currency but the annual interest rate in country x is 6 and the interest rate in country z is 3 all other things being equal it would make sense to borrow in the currency of z convert it in the spot market to currency x and invest the proceeds in country x however to repay the loan in currency z one must enter into a forward contract to exchange the currency back from x to z covered interest rate parity exists when the forward rate of converting x to z eradicates all the profit from the transaction since the currencies are trading at par one unit of country x s currency is equivalent to one unit of country z s currency assume that the domestic currency is country z s currency therefore the forward price is equivalent to 0 97 or 1 x 1 3 1 6 looking at the currency markets we can apply the forward foreign exchange rate formula to figure out what the gbp usd rate might be say the spot rate for the pair was trading at 1 35 also assume that the interest rate using the prime lending rate for the u s was 1 1 and 3 25 for the u k the domestic currency is the british pound making the forward rate 1 32 or 1 35 x 1 0 011 1 0 0325 the difference between covered interest rate parity and uncovered interest rate paritycovered interest parity involves using forward contracts to cover the exchange rate meanwhile uncovered interest rate parity involves forecasting rates and not covering exposure to foreign exchange risk that is there are no forward rate contracts and it uses only the expected spot rate there is no difference between covered and uncovered interest rate parity when the forward and expected spot rates are the same limitations of using covered interest rate parityinterest rate parity says there is no opportunity for interest rate arbitrage for investors of two different countries but this requires perfect substitutability and the free flow of capital sometimes there are arbitrage opportunities this comes when the borrowing and lending rates are different allowing investors to capture riskless yield for example the covered interest rate parity fell apart during the great financial crisis however the effort involved in capturing this yield usually makes it non advantageous to pursue | |
what is the covered interest rate parity | the covered interest rate parity is a theoretical occurrence where a pair s spot and forward currency prices are equal representing no arbitrage opportunity | |
what are the 2 types of interest rate parity | the two types are covered and uncovered the difference is that the covered type uses forward or futures contracts while the uncovered uses expected spot rates | |
when does interest rate parity not hold | interest rate parity does not hold when the spot and forward prices are not in equilibrium representing an arbitrage opportunity the bottom linecovered interest rate parity is a condition where a currency pair s spot and forward prices are equal it is used by currency traders to help them make decisions on arbitrage opportunities | |
what is creative destruction | creative destruction is the dismantling of long standing practices in order to make way for innovation and is seen as a driving force of capitalism understanding creative destructionthe term creative destruction was first coined by austrian economist joseph schumpeter in 1942 schumpeter characterized creative destruction as innovations in the manufacturing process that increase productivity describing it as the process of industrial mutation that incessantly revolutionizes the economic structure from within incessantly destroying the old one incessantly creating a new one investopedia alison czinkotabasically the theory of creative destruction assumes that long standing arrangements and assumptions must be destroyed to free up resources and energy to be deployed for innovation to schumpeter economic development is the natural result of forces internal to the market and is created by the opportunity to seek profit creative destruction theory treats economics as an organic and dynamic process this stands in stark contrast with the static mathematical models of traditional cambridge tradition economics equilibrium is no longer the end goal of market processes instead many fluctuating dynamics are constantly reshaped or replaced by innovation and competition as is implied by the word destruction the process inevitably results in losers and winners producers and workers committed to the older technology will be left stranded entrepreneurs and workers in new technologies meanwhile will inevitably create disequilibrium and highlight new profit opportunities in describing creative destruction schumpeter was not necessarily endorsing it in fact his work is considered to be heavily influenced by the communist manifesto the pamphlet by karl marx and friedrich engels which decried the bourgeoisie for its constant revolutionizing of production and uninterrupted disturbance of all social conditions 1 netflix is a modern example of creative destruction having overthrown disc rental and traditional media industries principles of creative destructioncreative destruction across industriescreative destruction can be seen across many different industries as all companies often strive to be better many businesses seek new ways to disrupt the status quo and seek new paths to better business opportunity some examples of those industries are below companies don t technically need to embark on creative destruction however by not doing so they risk the occurrence of falling behind their competition limitations of creative destructionthough creative destruction can lead to many long term positive aspects of economic growth and innovation it does come with downsides as old industries and technologies are replaced jobs may be lost this can lead to unemployment and hardship for those who are displaced due to the nature of their previous employment relating to an antiquated industry it can also take time for new jobs and industries to emerge the benefits of creative destruction may also not be evenly distributed wealth and power may become concentrated in the hands of a few individuals or companies that are able to succeed in the new markets this is often the case for those who have the best access to power capital or influence those who have already succeeded are also the most likely to have the best opportunity to embark on creative destruction the process of creative destruction may also have negative environmental consequences new technologies and products may have unforeseen environmental impacts that are not immediately apparent and the process of replacing old technologies with new ones may also have an environmental cost it may sometimes take years for enough evidence has been collected to truly see the long term implications of certain forms of innovation creative destruction examplesexamples of creative destruction in history include henry ford s assembly line and how it revolutionized the automobile manufacturing industry however it also displaced older markets and forced many laborers out of work the internet is perhaps the most all encompassing example of creative destruction where the losers were not only retail clerks and their employers but also bank tellers secretaries and travel agents the mobile internet added many more losers from taxi cab drivers to mapmakers the winners beyond the obvious example of programmers might be just as numerous the entertainment industry was turned upside down by the internet but its need for creative talent and product remains the same or greater the internet destroyed many small businesses but created many new ones online the point as schumpeter noted is that an evolutionary process rewards improvements and innovations and punishes less efficient ways of organizing resources the trend line is toward progress growth and higher standards of living overall | |
why is creative destruction a good thing | while creative destruction can cause short term pain and job losses it is generally seen as a positive force for long term economic growth and progress creative destruction is driven by innovation which is a key driver of economic growth creative destruction also encourages competition which helps to keep prices low and quality high last it may help the economy become more resilient by breaking up monopolies and reducing reliance on outdated industries or technologies | |
what emerges from creative destruction | creative destruction can give rise to entirely new industries that did not exist before for example the rise of the internet has created new industries such as e commerce social media and digital marketing this also means that existing products and services are replaced by new innovations which can lead to brand new business models last each of these items mentioned above can result in new jobs or employment sectors | |
what areas of the economy and markets is creative destruction used to describe | creative destruction can occur within almost any industry leading to the destruction of existing companies and the emergence of new ones it can further happen at a lower level such as individual products and services leading to the replacement of existing products and services with new ones by extension this all has an impact on jobs and employment simply put all industries markets and sectors are subject to innovation and can be the subject matter to creative destruction | |
what are modern examples of creative destruction | consider apple s frequent product releases when the company deems it necessary they release new gadgets hardware or software that usually takes the place of prior offerings this is an example of apple embarking on creative destruction where they make their older items obsolete in favor of coming up with innovative new solutions for long term benefit the bottom linecreative destruction is a concept introduced by economist joseph schumpeter that refers to the process of innovation and technological change that leads to the destruction of existing economic structures such as industries firms and jobs this destruction paves the way for new structures to emerge thereby creating long term economic growth and progress though potential short term downsides creative destruction has the intention of creating long term value | |
what is credit | the word credit has many meanings in the financial world but it most commonly refers to a contractual agreement in which a borrower receives a sum of money or something else of value and commits to repaying the lender at a later date typically with interest credit can also refer to the creditworthiness or credit history of an individual or a company as in she has good credit in the world of accounting it refers to a specific type of bookkeeping entry investopedia sydney saporitocredit in lending and borrowingcredit represents an agreement between a creditor lender and a borrower debtor the debtor promises to repay the lender often with interest or risk financial or legal penalties extending credit is a practice that goes back thousands of years to the dawn of human civilization according to the anthropologist david graeber in his book debt the first 5000 years there are many different forms of credit common examples include car loans mortgages personal loans and lines of credit essentially when the bank or other financial institution makes a loan it credits money to the borrower who must pay it back at a future date credit cards may be the most ubiquitous example of credit today allowing consumers to purchase just about anything on credit the card issuing bank serves as an intermediary between buyer and seller paying the seller in full while extending credit to the buyer who may repay the debt over time while incurring interest charges until it is fully paid off similarly if buyers receive products or services from a seller who doesn t require payment until later that is a form of credit for example when a restaurant receives a truckload of produce from a wholesaler who will bill the restaurant for it a month later the wholesaler is providing the restaurant owner with a form of credit other definitions of credit credit is also used as shorthand to describe the financial soundness of businesses or individuals someone who has good or excellent credit is considered less of a risk to lenders than someone with bad or poor credit credit scores are one way that individuals are classified in terms of risk not only by prospective lenders but also by insurance companies and in some cases landlords and employers for example the commonly used fico score ranges from 300 to 850 anyone with a score of 800 or higher is considered to have exceptional credit 740 to 799 represents very good credit 670 to 739 is good credit 580 to 669 is fair and a score of 579 or less is poor 1companies are also judged by credit rating agencies such as moody s and standard and poor s and given letter grade scores representing the agency s assessment of their financial strength those scores are closely watched by bond investors and can affect how much interest companies will have to offer in order to borrow money similarly government securities are graded based on whether the issuing government or government agency is considered to have solid credit u s treasuries for example are backed by full faith and credit of the united states in the world of accounting credit has a more specialized meaning it refers to a bookkeeping entry that records a decrease in assets or an increase in liabilities as opposed to a debit which does the opposite for example suppose that a retailer buys merchandise on credit after the purchase the company s inventory account increases by the amount of the purchase via a debit adding an asset to the company s balance sheet however its accounts payable field also increases by the amount of the purchase via a credit adding a liability | |
what is a letter of credit | often used in international trade a letter of credit is a letter from a bank guaranteeing that a seller will receive the full amount that it is due from a buyer by a certain agreed upon date if the buyer fails to do so the bank is on the hook for the money | |
what is a credit limit | a credit limit represents the maximum amount of credit that a lender such as a credit card company will extend such as to a credit card holder once the borrower reaches the limit they are unable to make further purchases until they repay some portion of their balance the term is also used in connection with lines of credit and buy now pay later loans | |
what is a line of credit | a line of credit refers to a loan from a bank or other financial institution that makes a certain amount of credit available to the borrower for them to draw on as needed rather than taking all at once one type is the home equity line of credit heloc which allows owners to borrow against the value of their home for renovations or other purposes | |
what is revolving credit | revolving credit involves a loan with no fixed end date a credit card account being a good example as long as the account is in good standing the borrower can continue to borrow against it up to whatever credit limit has been established as the borrower makes payments toward the balance the account is replenished these kinds of loans are often referred to open end credit mortgages and car loans by contrast are considered closed end credit because they come to an end on a certain date the bottom linethe word credit has multiple meanings in personal and business finance most often it refers to the ability to buy a good or service and pay for it at some future point credit may be arranged directly between a buyer and seller or with the assistance of an intermediary such as a bank or other financial institution credit serves a vital purpose in making the world of commerce run smoothly | |
what is a credit analyst | the term credit analyst refers to a financial professional who assesses the creditworthiness of securities individuals or companies credit analysts determine the likelihood that a borrower can repay their financial obligations by reviewing their financial and credit history and determining whether the state of the subject s financial health and the economic conditions are favorable to repayment these professionals generally have an academic background in finance accounting or a related field credit analysts can find work in different financial institutions | |
how credit analysts work | a credit analyst gathers and analyzes financial data associated with lending and credit products this includes reviewing a borrower s payment history along with liabilities earnings and assets they possess the analyst looks for indicators that the borrower might present a level of risk the data are used to recommend the approval or denial of credit and to determine whether to increase or reduce credit limits or charge additional fees 1a key component of their jobs is to interpret financial statements and use ratios to analyze the fiduciary behavior and history of a potential borrower they decide whether the borrower has adequate cash flows by comparing ratios with industry data benchmarks for example a credit analyst working at a bank may examine an agricultural company s financial statements before approving a loan for new farm equipment 1credit analysts are required to have a background in finance economics math accounting or other related field candidates with bachelor s degrees and experience are preferred although a potential employer may overlook experience if someone has a graduate degree some analysts also have advanced certification such as training offered through the national association of credit analysts employment is offered at a variety of financial institutions including banks investment companies credit unions credit rating agencies insurance companies and asset management companies analysts who work in securities commodity contracts and other areas of financial investments earn the highest salaries 2the mean annual salary for a credit analyst in 2020 the highest in the u s was 125 900 in new york state 2special considerationscredit analysts are often called credit risk analysts that s because credit analysis is a specialized area of financial risk analysis analysts evaluate the risk investments hold and determine the interest rate and credit limit or loan terms for a borrower they use their research to ensure the borrower receives an affordable loan and the lender is protected if the borrower defaults analysts may recommend a business loan or business credit after considering certain risk factors these factors may be environment oriented such as economic changes stock market fluctuations legislative changes and regulatory requirements if a business client struggles to meet payroll it could be indicative of a decline in revenue and potential bankruptcy which may affect the bank s assets ratings and reputation banks can use financial data to determine whether they want to approve certain loans by analyzing how much risk is involved in lending if a loan is approved the credit analyst monitors the borrower s performance and may recommend terminating the agreement if it becomes risky determining the level of risk in a loan or investment helps banks manage risks and generate revenue for example a credit analyst may recommend a solution for an individual who has defaulted on their credit card payments the analyst may recommend reducing their credit limit closing their account or offering them a new credit card with a lower interest rate credit analysts play a key role in the well being of the economy because credit stimulates financial activity access to credit provides consumers with additional spending power which helps improve individuals lifestyles and gives businesses temporary liquidity credit analysts and credit ratingscredit analysts may also issue credit scores a credit score is a three digit number ranging from around 200 to 850 the most common type of individual credit score is the fico score credit score generation is typically automated for individuals through algorithmic processes based on their credit payment histories spending and past bankruptcies scores for debt issuers and their instruments such as bonds are based on letter grades the highest is aaa followed by aa bbb and so on a company s debt is considered junk or below investment grade once it goes below a certain rating these investments typically carry higher yields to accommodate for the additional credit risk 3sovereign governments can also have credit scores on their bonds credit analysts who assess bonds often work at credit rating agencies such as moody s or standard poor s s p insurance companies are also rated on their credit risk and financial stability by rating agencies such as am best | |
what skills do you need to be a credit analyst | a credit analyst should have accounting skills such as the ability to create and analyze financial statements and ledgers many credit analysts will have skills in risk analysis mathematics statistics computing and quantitative analysis credit analysts should be good at problem solving have attention to detail and have the ability to research and document their findings they should be able to understand and apply the terms used in finance banking and business | |
how do i become a credit analyst | to become a credit analyst you will usually be required to have a minimum of a bachelor s degree in finance accounting or a related field a potential employer may look to see if you have completed courses in statistics economics financial statement analysis and risk assessment they may also require some previous on the job experience in accounting banking or finance industry certifications can also help you land a job as a credit analyst or advance your career in the field common certifications for credit analysts include credit risk certification crc credit business associate cba credit business fellow cbf professional certificate in credit and certified credit executive cce some credit analysts have chartered financial analyst cfa or certified risk analyst cra certifications | |
is a credit analyst a good job | yes a credit analyst can be a good job if you have an interest in accounting or finance along with a desire to help companies and consumers make decisions regarding the extension of credit and the reduction of financial risk according to the u s bureau of labor statistics bls the estimated wage range for credit analysts in 2020 was 44 250 to 146 690 the mean annual wage for credit analysts was 86 170 2the top paying industries for credit analysts are monetary authorities central banks securities commodities and financial investment companies insurance carriers and business support firms the states with the highest employment levels for credit analysts are california new york texas florida and illinois 2 | |
what is a credit bureau | a credit bureau also known in the u s as a credit reporting agency is an organization that collects and researches individual credit information and sells it to creditors for a fee so they can make decisions about extending credit or granting loans | |
how credit bureaus work | credit bureaus partner with all types of lending institutions and credit issuers to help them make loan decisions their primary purpose is to ensure that creditors have the information they need to make lending decisions typical clients for a credit bureau include banks mortgage lenders credit card issuers and other personal financial lending companies 1credit bureaus are not responsible for deciding whether or not an individual should have credit extended to them they merely collect and synthesize information about an individual s credit score and give that information to lending institutions consumers can also be customers of credit bureaus and they receive the same service information about their credit history 1credit scorescredit bureaus acquire their information from data providers which can be creditors debtors debt collection agencies vendors or offices with public records court records for example are publicly available most credit bureaus focus on credit accounts however some also access more comprehensive information including payment history on cellphone bills utility bills rent and more credit bureaus then use a range of methodologies to calculate a person s credit score based on this credit history 1fico scores created by the fair isaac corporation in 1989 are the most common credit scores in the u s 2 there are 19 commonly used fico scores and each is calculated differently with an eye toward different types of clients allowing credit issuers to choose the type of credit score that best fits their inquiry 3credit bureaus then add the credit score to the information they ve accumulated and issue a comprehensive credit report which provides credit issuers with information that helps them determine credit approval and appropriate interest rates for borrowers an individual with a higher credit score will likely have a lower interest rate on a loan 4of lenders in the u s rely on a fico score to help them decide whether or not to offer credit and on what terms 5major credit bureausthough there are several credit bureaus currently operating in the u s the three main ones are equifax experian and transunion 6 in addition to using fico scores these three bureaus have also combined to create their credit score the vantagescore 7both scores are calculated on a range from 300 to 850 although the vantagescore initially used a 501 to 990 range and some industry specific fico scores are graded on a 250 to 900 scale however fico and vantagescore weigh the importance of individual categories differently and so are generally dissimilar in their scores a good fico score for example is considered to be in the 670 to 719 range while a good vantagescore is in the 661 to 780 range 89another major difference between the scores has to do with their sources vantagescores create a single score that can go with a credit report from each of the bureaus based on information from all three bureaus fico on the other hand only uses information from one bureau for its score so for example you could have three different versions of your fico score one for each of the three credit bureaus 8you are entitled to one free credit report every 12 months from each bureau but you may have to pay to see your credit score 10credit bureau regulationthough credit bureaus don t make lending decisions they are very powerful financial institutions and the information contained in their reports can have a substantial impact on an individual s financial future the fair credit reporting act fcra passed in 1970 regulates credit bureaus and their use and interpretation of consumer data it is primarily designed to protect consumers from negligent or deliberately fraudulent information in their credit score reports 11in 2003 the fair and accurate credit transactions act facta updated the fair credit reporting act to give consumers the right to get one free credit report every 12 months from credit bureaus it also gave them the right to purchase a credit score complete with information as to how that score was calculated 12 | |
what is a credit card | a credit card is a thin rectangular piece of plastic or metal issued by a bank or financial services company that allows cardholders to borrow funds with which to pay for goods and services with merchants that accept cards for payment credit cards impose the condition that cardholders pay back the borrowed money plus any applicable interest as well as any additional agreed upon charges either in full by the billing date or over time in addition to the standard credit line the credit card issuer may also grant a separate cash line of credit loc to cardholders enabling them to borrow money in the form of cash advances that can be accessed through bank tellers atms or credit card convenience checks such cash advances typically have different terms such as no grace period and higher interest rates compared with those transactions that access the main credit line issuers customarily preset borrowing limits based on an individual s credit rating a vast majority of businesses let the customer make purchases with credit cards which remain one of today s most popular payment methodologies for buying consumer goods and services investopedia ellen lindnerunderstanding credit cardscredit cards typically charge a higher annual percentage rate apr vs other forms of consumer loans interest charges on any unpaid balances charged to the card are typically imposed approximately one month after a purchase is made except in cases where there is a 0 apr introductory offer in place for an initial period of time after account opening unless previous unpaid balances had been carried forward from a previous month in which case there is no grace period granted for new charges by law credit card issuers must offer a grace period of at least 21 days before interest on purchases can begin to accrue 1 that s why paying off balances before the grace period expires is a good practice when possible it is also important to understand whether your issuer accrues interest daily or monthly as the former translates into higher interest charges for as long as the balance is not paid this is especially important to know if you re looking to transfer your credit card balance to a card with a lower interest rate mistakenly switching from a monthly accrual card to a daily one may potentially nullify the savings from a lower rate individuals with poor credit histories often seek secured credit cards which require cash deposits that afford them commensurate lines of credit types of credit cardsmost major credit cards which include visa mastercard discover and american express are issued by banks credit unions or other financial institutions many credit cards attract customers by offering incentives such as airline miles hotel room rentals gift certificates to major retailers and cash back on purchases these types of credit cards are generally referred to as rewards credit cards to generate customer loyalty many national retailers issue branded versions of credit cards with the store s name emblazoned on the face of the cards although it s typically easier for consumers to qualify for a store credit card than for a major credit card store cards may be used only to make purchases from the issuing retailers which may offer cardholders perks such as special discounts promotional notices or special sales some large retailers also offer co branded major visa or mastercard credit cards that can be used anywhere not just in retailer stores secured credit cards are a type of credit card where the cardholder secures the card with a security deposit such cards offer limited lines of credit that are equal in value to the security deposits which are often refunded after cardholders demonstrate repeated and responsible card usage over time these cards are frequently sought by individuals with limited or poor credit histories similar to a secured credit card a prepaid debit card is a type of secured payment card where the available funds match the money that someone already has parked in a linked bank account by contrast unsecured credit cards do not require security deposits or collateral these cards tend to offer higher lines of credit and lower interest rates vs secured cards sabrina jiang investopedia 2020building credit history with credit cards | |
when used responsibly regular non secured and secured cards can help consumers build a positive credit history while providing a way to make online purchases and eliminate the need to carry cash since both types of credit cards report payments and purchasing activity to the major credit agencies cardholders who use their card responsibly can build strong credit scores and potentially extend their lines of credit and in the case of secured cards potentially upgrade to a regular credit card | building a good credit history is a combination of things making regular on time payments avoiding late payments keeping credit utilization under your credit limit and maintaining a low debt to income ratio by making responsible purchases and paying them off in a timely manner a credit score will rise making a consumer more attractive to other lenders also while it s best to pay off your balance each month your card issuer won t allow you to use another card to do that | |
how do i get a credit card if i don t have any credit | building credit history can be a bit of a catch 22 if you don t have any credit merchants or banks are less likely to extend credit to you since you re an unproven borrower opening a secured credit card is one of the simplest ways to get started since spenders are only borrowing from the money they put down as a deposit there is little risk for the lender and it gives them a snapshot of your spending and repayment habits another way to start building credit is to become an authorized user on an established credit account such as a parent or spouse the cardholder s credit history will appear on your account adding longevity to your credit report but be sure that the person with whom you partner has good credit habits if their financial choices are poor that will also reflect on you 2 | |
do credit cards have fixed or variable annual percentage rates aprs | many credit cards will have both types of annual percentage rates aprs to find out which kind of apr you have read the cardholder agreement that comes with your credit card card issuers must legally disclose what type of apr they have and what it is if a fixed apr changes they must also alert consumers of that 3some credit cards have fixed aprs for purchases but variable aprs for cash advances or late payments read the fine print to make sure | |
what is a credit card annual fee | the annual fee on a credit card is the fee charged by the card issuer to extend the credit card to you some cards don t charge an annual fee but others most often cards that offer rewards or incentives like cash back can charge annual fees ranging from 50 to 700 | |
what is the difference between the transaction date and the posting date | the transaction date is the day of the purchase or payment using your card these transactions will usually move into a pending category while the company processes the activity the posting date is the day that the purchase or payment is added or deducted from your account balance | |
what is a credit card balance | a credit card balance is the total amount of money currently owed by a cardholder to their credit card company balances change based on when and how they are used they increase when purchases are made and decrease when cardholders make payments any remaining balance at the end of the billing cycle is carried over to the next month s bill and incurs an interest charge credit card balances are important factors in calculating a person s credit score future creditors look at them to determine the risk and cost of granting their customers additional credit understanding credit card balancescredit cards are payment cards that allow individuals and business owners to make purchases without having to immediately fork over any cash they give cardholders the chance to pay for their goods and services later while providing them with a secure and safer method to shop unlike cash credit cards are generally accepted worldwide and may offer incentives like points or cashback the balance on your credit card is the total amount of money you owe to your credit card issuer this amount changes each month based on how you use your card it is made up of different factors including payments are also a key component of your credit card balance and it s always advisable to pay off your statement balance in full before the due date if you make only the minimum payment the remaining balance rolls over into the next billing cycle you incur interest on whatever remains which is reflected on your next statement new credit card balances are commonly updated anywhere from 24 to 72 hours once a purchase or payment is processed the length of time depends on the credit card company and how the transaction was executed if you return an item purchased on your credit card the merchant will issue a refund to your account this amount is also reflected in your credit card balance the length of time for a refund to be generated depends on the retailer and the type of purchase but it generally takes anywhere from a few to 15 days for the refund to be applied to your balance if you had any points or cashback that amount will be deducted special considerationsthe best approach to managing your credit card and therefore your credit effectively is to pay your balance off in full a zero balance helps avoid the interest charges associated with maintaining a balance if you have no other option try paying more than the minimum monthly payment as this knocks off more of the balance and accumulates less interest that you ll owe to the card issuer but sometimes it s just not that simple you may find yourself in a situation where you can only make the minimum payment if you do that know that it will take a long time to pay off the balance although you ll pay more in interest you won t damage your credit score you can keep your credit score intact or improve it by paying the bill before the card issuer reports to the credit reporting agency doing so ensures that there s a lower balance reported to the credit bureaus each month if you re having trouble fully paying off your credit card balance each month then it may be worth switching to a balance transfer credit card to secure a lower interest rate late payments can add up if you re having trouble paying your bills each month payment history accounts for 35 to 40 of your credit score depending on which score your lender uses carrying a credit card balance generally isn t a good idea because it can affect your credit score revolving credit credit cards and lines of credit factors into your credit utilization ratio which is the total amount of credit you use at a particular time divided by the total amount you have available or the sum of all your credit limits it s a good idea to have a ratio of under 30 if you have a credit limit of 5 000 and keep a balance of 4 000 on your credit card then your credit utilization is 80 which is extremely high this tells creditors that you aren t responsible as such you may be deemed high risk for defaulting on any future debt so the chances of getting a new loan or credit card may be slim if you keep your ratio down it suggests that you re better able to manage credit responsibly keeping a high credit card balance can make you financially vulnerable in other ways too you won t be able to use your card in an emergency if you maintain a high balance especially if it s too close to your credit limit you re also at risk of paying additional interest and or late fees if your debt increases to an amount that you can t maintain talk to your credit card company to see if you qualify for an automatic increase of your credit limit this can effectively drop your credit utilization ratio down but keep in mind that your card issuer may have to pull a hard inquiry if you don t which means your score may drop as a result credit card balance vs statement balanceyour credit card balance is the total that you owe today as such it s also called your current balance this figure is different from your statement balance which is the amount that is reflected on your bill this figure is calculated at the end of the billing cycle up to the closing date and printed on your bill you will see this noted as the new balance on the statement to keep your credit card in good standing pay this amount or the minimum payment listed on the statement if you pay off the statement balance each month you avoid paying interest on your purchases altogether 1 the statement balance does not include any charges incurred or payments made on the credit card after the statement closing date | |
what is a credit card dump | a credit card dump is a type of crime in which the criminal makes an unauthorized digital copy of a credit card this type of crime has existed for decades but it has seen wider public awareness in recent years due to the rising prevalence of credit card forgeries identity theft and other types of cybercrime | |
how credit card dumps work | there are many ways in which a credit card dump might occur one common method is skimming in which an illegal card reader sometimes hidden in a legitimate automated teller machine atm or gas station pump copies the data from a credit card in other cases cybercriminals are able to obtain a large number of card numbers at once by compromising the computer systems of companies handling customer credit card information for example criminals might access thousands of retail customers credit card numbers by infecting the point of sale pos devices of a large retail chain although measures such as personal information numbers pins and security chips can help make this theft more difficult hackers nonetheless continue to find new ways to exploit weaknesses in the electronic payments system in order to capture valuable credit card information to profit from this theft cybercriminals resell the credit card information on the black market alternatively hackers could also use the information themselves in order to make unauthorized online purchases using stolen credit cards protecting against credit card dumpsultimately consumers have limited means to protect themselves against the risk of cybercrime after all even the most cautious individuals might fall victim to credit card theft if hackers manage to compromise the systems of the companies where they shop nevertheless there are steps individuals can take to reduce some of their risks these include refraining from sharing their credit card information with others keeping their credit cards close at hand when in public places checking for any suspicious objects on or around atms gas pumps and pos machines and regularly reviewing their credit card statements for any unfamiliar transactions examples of credit card dumpsunfortunately there is no shortage of examples in which hackers managed to compromise vast amounts of credit card data from unsuspecting customers here are just a few examples capital one the fifth largest credit card issuer in the united states revealed in july 2019 that a hacker accessed the personal information of around 106 million customers and applicants in the u s and canada the information that was accessed included highly personal details on consumers and small businesses including names social security numbers income and dates of birth as of the time they applied for one of several credit card products from 2005 through early 2019 1 to date the capital one hack is the second largest such data dump of all time data dumps don t only happen in america in may 2019 for example the popular australian graphic design website canva was breached by hackers with nearly 140 million user accounts compromised in addition to personal information such as names usernames and email addresses the hackers also managed to access users credit card information 2another notable incident occurred in october 2013 when adobe adbe lost nearly 3 million customer credit card records in a large scale attack by hackers the breach was part of a larger effort in which data from over 150 million users was also stolen the company ultimately reached a roughly 1 million settlement with its customers over the incident 3 | |
what was the biggest credit card dump to date | in terms of the number of customers exposed the largest credit card dump so far was a hack on credit bureau equifax in september of 2017 which exposed personal data of more than 147 million customers including credit card details 4 | |
what was the first credit card dump | card theft scams and black markets for personal ids have been around since the advent of credit cards in the 1960s and 70s the first large scale credit card dump however is often attributed to the year 1984 when the new york times reported that the password for a leading credit union trw was stolen from a sears store on the west coast that password unlocked the credit histories and personal information of many sears customers that would subsequently be used to obtain their credit card numbers 5 | |
how can i avoid being a victim of a credit card dump | unfortunately since credit card dumps involve security breaches of companies that you may shop at having your card numbers stolen may be out of your hands if you are aware of a breach contact your credit card issuer immediately to put a freeze on your account and cancel replace your cards another newer innovation is the use of virtual credit card numbers many banks and card companies today allow you to generate a temporary credit card number online that can be used for online shopping this number however would not be able to be used again for subsequent purchases | |
what is a credit default swap cds | a credit default swap cds is a financial derivative that allows an investor to swap or offset their credit risk with that of another investor to swap the risk of default the lender buys a cds from another investor who agrees to reimburse them if the borrower defaults most cds contracts are maintained via an ongoing premium payment similar to the regular premiums due on an insurance policy a lender who is worried about a borrower defaulting on a loan often uses a cds to offset or swap that risk 1 | |
how credit default swaps cdss work | a credit default swap is a derivative contract that transfers the credit exposure of fixed income products it may involve bonds or forms of securitized debt derivatives of loans sold to investors for example suppose a company sells a bond with a 100 face value and a 10 year maturity to an investor the company might agree to pay back the 100 at the end of the 10 year period with regular interest payments throughout the bond s life because the debt issuer cannot guarantee that it will be able to repay the premium the investor assumes the risk the debt buyer can purchase a cds to transfer the risk to another investor who agrees to pay them in the event the debt issuer defaults on its obligation 1debt securities often have longer terms to maturity making it harder for investors to estimate the investment risk for instance a mortgage can have terms of 30 years there is no way to tell whether the borrower will be able to continue making payments that long that s why these contracts are a popular way to manage risk the cds buyer pays the cds seller until the contract s maturity date in return the cds seller agrees that it will pay the cds buyer the security s value as well as all interest payments that would have been paid between that time and the maturity date if there is a credit event 1credit default swaps and credit eventsthe credit event is a trigger that causes the cds buyer to settle the contract credit events are agreed upon when the cds is purchased and are part of the contract the majority of single name cdss are traded with the following credit events as triggers terms of a cds | |
when a credit event occurs the contract may be settled physically historically the most common method or by cash in a physical settlement sellers receive an actual bond from the buyer cash settlement though became the more preferred method when the purpose of cdss shifted from hedging tools to speculation in this type of settlement the seller is responsible for paying the buyer for losses 6 | the u s comptroller of the currency issues a quarterly report on credit derivatives in a report regarding the first quarter of 2024 it placed the size of the entire credit derivative market at 4 7 trillion 3 2 trillion of which were cdss 2 | |
when are cdss used | as an insurance policy against a credit event on an underlying asset credit default swaps are used in several ways because swaps are traded they naturally have fluctuating market values that a cds trader can profit from investors buy and sell cdss from each other attempting to profit from the difference in prices 1a credit default swap by itself is a form of hedging a bank might purchase a cds to hedge against the risk of the borrower defaulting insurance companies pension funds and other securities holders can purchase cdss to hedge credit risk 7arbitrage generally involves purchasing a security in one market and selling it in another cdss can be used in arbitrage an investor can purchase a bond in one market then buy a cds on the same reference entity on the cds market 8a credit default swap is the most common form of credit derivative and may involve municipal bonds emerging market bonds mortgage backed securities mbs or corporate bonds 9the great recessioncdss played a key role in the credit crisis that eventually led to the great recession credit default swaps were issued by american international group aig bear sterns and lehman brothers to investors to protect against losses if the mortgages that were securitized into mortgage backed securities mbs defaulted mortgage backed securities are mortgages bundled into packages and then offered as shares the cdss were insurance against mortgage defaults so investors believed that they had completely reduced the risk of loss if the worst were to happen mortgages were given to nearly anyone that requested them because investment banks and real estate investors were generating huge returns as housing prices continued to climb cdss allowed investment banks to create synthetic collateralized debt obligation instruments which were bets on securitized mortgage prices 10many investment banks issued mbss cdss and cdos they were all betting on the performance of their own mortgage security derivatives when housing prices collapsed the big players could not pay all of their obligations because they owed each other and investors more money than they had 11because these investment banks were so entwined in global markets their insolvency caused global markets to waver and ushered in the financial crisis of 2007 2008 10mechanics of credit default swapsthe settlement process of credit default swaps involves several mechanisms aimed at determining the compensation owed to the protection buyer in the event of a credit event there are two main methods of settlement physical settlement and cash settlement in physical settlement the protection buyer receives the underlying debt securities from the protection seller upon the occurrence of a credit event the notional amount of the cds contract represents the face value of the underlying debt securities the protection buyer can then either hold the bonds as an investment or sell them in the secondary market in cash settlement the compensation owed to the protection buyer is determined based on the results of a credit event auction conducted by a designated auction administrator the auction aims to establish a market based price for the defaulted debt securities the final price is then used to calculate the cash settlement amount cash settlement is generally preferred in situations where there is limited liquidity in the underlying bond market advantages and disadvantages of cdsscredit default swaps offer several advantages for investors and institutions while credit default swaps offer the advantages above they also come with several downsides can reduce risk to lendersno underlying asset exposuresellers can spread riskcan create profitability opportunitiescan be customizedcan give lenders and investors a false sense of securitytraded over the counterseller inherits substantial riskmay be illiquid at timesmay be too complex for beginning investorscredit default swaps and counterparty riskas mentioned above counterpart risk represents the risk that the other party in the cds contract will default on its obligations in the context of cds counterparty risk arises because these contracts are typically traded over the counter between two parties without the oversight of a centralized exchange in a cds contract the protection buyer pays regular premiums to the protection seller in exchange for protection against credit events affecting a specified reference entity if a credit event occurs such as the default of the reference entity the protection seller is obligated to compensate the protection buyer for the losses incurred however if the protection seller defaults the protection buyer may not receive the compensation owed exposing them to the full credit risk associated with the reference entity therefore there is investment risk not necessarily with the product being held but with the entity in which it is associated with investors can employ various strategies to manage counterparty risk effectively they can and should conduct due diligence on potential counterparties to assess their financial health and creditworthiness they can diversify counterparty exposure by spreading trades across multiple counterparties they can use collateral agreements and credit support annexes to secure their positions and require counterparties to post collateral as security against potential losses | |
what triggers a credit default swap | the cds provider must pay the swap purchaser if the underlying investment usually a loan is subject to a credit event 6 | |
is a credit default swap legal | credit default swaps are not illegal but they are regulated by the securities and exchange commission and the commodity futures trading commission under the dodd frank act 12 | |
what are the benefits of credit default swaps | credit default swaps are beneficial for two main reasons hedging risk and speculation to hedge risk investors buy credit default swaps to add a layer of insurance to protect a bond such as a mortgage backed security from defaulting on its payments in turn a third party assumes the risk in exchange for a premium by contrast when investors speculate on credit default swaps they are betting on the credit quality of the reference entity 1the bottom linecredit default swaps are sold to investors to mitigate the risks of underlying asset defaults they were highly used in the past to reduce the risks of investing in mortgage backed securities and fixed income products which contributed to the financial crisis of 2007 2008 and the european sovereign debt crisis 410 | |
what is a credit facility | a credit facility is a type of loan made in a business or corporate finance context it allows the borrowing business to take out money over an extended period of time rather than reapplying for a loan each time it needs money in effect a credit facility lets a company take out an umbrella loan for generating capital over an extended period of time 1various types of credit facilities include revolving loan facilities committed facilities letters of credit and most retail credit accounts investopedia michela buttignol | |
how credit facilities work | credit facilities are used broadly across the financial market as a way to provide funding for different purposes companies frequently implement a credit facility in conjunction with closing a round of equity financing or raising money by selling shares of their stock a key consideration for any company is how it will incorporate debt in its capital structure while considering the parameters of its equity financing the company may take out a credit facility based on collateral that may be sold or substituted without altering the terms of the original contract the facility may apply to different projects or departments in the business and be distributed at the company s discretion the period for repaying the loan is flexible and like other loans depends on the credit situation of the business and how well it has paid off debts in the past 1the summary of a facility includes a brief discussion of the facility s origin the purpose of the loan and how funds are distributed specific precedents on which the facility rests are included as well for example statements of collateral for secured loans or particular borrower responsibilities may be discussed a credit facility isn t debt a credit facility gives the holder the right to demand loan funds in the future and the borrower is only indebted when they draw on the credit facility 1credit facility detailsa credit facility agreement details the borrower s responsibilities loan warranties lending amounts interest rates loan duration default penalties and repayment terms and conditions the contract opens with the basic contact information for each of the parties involved followed by a summary and definition of the credit facility itself the terms of interest payments repayments and loan maturity are detailed they include the interest rates and date for repayment if a term loan or the minimum payment amount and recurring payment dates if a revolving loan the agreement details whether interest rates may change and specifies the date on which the loan matures if applicable the credit facility agreement addresses the legalities that may arise under specific loan conditions such as a company defaulting on a loan payment or requesting a cancellation the section details penalties the borrower faces in the event of a default and steps the borrower takes to remedy the default a choice of law clause itemizes particular laws or jurisdictions consulted in case of future contract disputes types of credit facilitiescredit facilities come in a variety of forms some of the most common include a retail credit facility is a method of financing essentially a type of loan or line of credit used by retailers and real estate companies credit cards are a form of retail credit facility 2a revolving loan facility is a type of loan issued by a financial institution that gives the borrower the flexibility to draw down or withdraw repay and withdraw again 3 essentially it s a line of credit with a variable fluctuating interest rate a committed facility is a source for short or long term financing agreements in which the creditor is committed to providing a loan to a company given the company meets specific requirements set forth by the lending institution the funds are provided up to a maximum limit for a specified period and at an agreed interest rate term loans are a typical type of committed facility 4a credit facility can either be classified as short term or long term short term credit facilities often use inventory or operating receivables as collateral and have more favorable loan terms due to their short term nature long term credit facilities are more costly to compensate for risk although they offer a company the greatest flexibility pros and cons of credit facilitiescredit facilities or other lines of credit offer tremendous flexibility for companies that aren t sure what their future credit needs will be however securing this type of line of credit may be difficult and expensive here are the advantages and disadvantages to a credit facility provides a company financial flexibilitystrengthens the relationship between a financial institution and a companyoften increases the credit rating of a companymay require less administrative burden to secure future debtoften results in added maintenance and withdrawal feesmay be difficult for younger or riskier companies to secureoften requires a burdensome process to securemay require additional administrative burden to maintain loan covenantsthough credit facilities are generally not used to support day to day operations and ensure a company s survival a credit facility gives a company more resources to thrive operationally saving operating cash flow for strategic expansion allows the company to grow while credit facility cash flow can be used for one time or emergencies a credit facility also bolsters a company s ability to remain solvent should its business be cyclical or seasonal credit facility examplein 2019 tradeweb markets collaborated with financial institutions to secure a 500 million revolving credit facility proceeds from the facility were intended to be used for general corporate purposes and the lead legal arranger for the facility was cahill gordon reindel llp 5 as of dec 31 2022 tradeweb markets had drawn down 500 million with remaining availability of 499 5 million 6due to the significant size of this credit facility the indebtedness is with a syndicate of banks with the lead administrative agent being citibank n a 7 the credit agreement imposes a maximum total net leverage ratio and minimum cash interest coverage ratio requirement subject to satisfaction of certain conditions tradeweb markets can increase the credit facility by an additional 250 million with consent from all syndicate lenders 6in the example tradeweb markets also notes risks related to this indebtedness including | |
what are the types of credit facilities | there are several credit facilities a company can secure a revolving loan facility allows a company to take out a loan repay the loan then use the same loan agreement again as long as there are principal funds available to borrow a retail credit facility is often used to provide liquidity for cyclical companies that rely on inventory or high turnover of sales a committed credit facility is a specifically negotiated set of terms that obligates a lender to lend money to a borrower should the borrowing company meet specific criteria | |
what is the difference between a loan and a credit facility | a loan is often a more rigid agreement between a bank and a borrower the borrower usually receives the funds upfront and then repays it with interest a credit facility is more flexible as the agreement allows a borrower to take on debt only when they need the funds | |
what is a credit card facility | a credit card facility is different than a credit facility the term credit card facility is often used to describe features of a credit card that a cardholder receives when a credit card is opened for example a credit card may come with technology allowing for transactions to be automatically paid split into tracking categories or transferred to other cards | |
is credit facility used in debt | a credit facility is a way for a company to take on debt it s an agreement between a company and a lender that should the company need funds it can draw on the facility and borrow money just because a company has a credit facility doesn t mean it has incurred debt a credit facility simply grants the company the right to take on loan funds the bottom linea credit facility is an agreement between a lender and a borrower that allows for greater flexibility than traditional loans types of these include revolving loan facilities retail credit facilities like credit cards committed facilities letters of credit and most retail credit accounts a credit facility often allows a company more control over the amount and timing of debt as well as the use of funds than other types of lending agreements on the downside a credit facility usually comes with debt covenants additional maintenance fees withdrawal fees and is more difficult to secure credit facilities terms and particulars as with most loans depend on the financial condition of the borrowing company and its credit history | |
what is a credit limit | a credit limit is the maximum amount of credit a financial institution extends to a client on a credit card or a line of credit lenders usually set credit limits based on specific information about the credit seeking applicant including their income and employment status credit limits are an important factor that can affect consumers credit scores and their ability to obtain credit in the future investopedia julie bang | |
how a credit limit works | a credit limit is the maximum amount of money a lender will allow you to spend using a particular credit card or revolving line of credit lenders set those limits based on several factors including your credit score personal income and loan repayment history lenders generally offer higher limits to borrowers they view as lower risks 1credit limits can apply to both secured and unsecured credit if the line of credit is secured or backed by collateral the lender takes the value of the collateral into account and may offer a higher limit for example if you take out a home equity line of credit heloc your credit limit will be based in part on the equity in your home 2lenders will generally issue higher credit limits to creditors they consider to be lower risk and put lower credit limits on riskier borrowers a credit limit works the same way regardless of whether you have a credit card or a line of credit you can spend up to the credit limit if you exceed the credit limit you may face fines or penalties on top of your regular payment if the you spend less than the limit you can continue to use the card or line of credit until you reach the limit a downside to high credit limits is that they can potentially lead to overspending to the point where you cannot afford your monthly payments credit limit vs available credita credit limit and available credit are not the same the credit limit is the total amount you can borrow whereas available credit is the amount that is remaining for you to use including if you carry a balance for example if you have a credit card with a 1 000 credit limit and you charge 600 you have an additional 400 to spend if you make a 40 payment your balance would fall to 560 and you would then have 440 in available credit | |
how credit limits affect your credit score | your credit limits can have an impact on your credit score an important number that lenders use to decide whether to issue you new credit and what interest rate to charge you for it that s because your credit utilization ratio or the amount of debt you have outstanding at any given time as a percentage of the total credit you have access to is one of the factors that goes into computing your score the lower that percentage the better so it pays to be aware of your credit limits and try to keep your borrowing well beneath them generally speaking lenders look unfavorably on a credit utilization ratio that exceeds 30 3can lenders change your credit limit in most cases lenders reserve the right to change credit limits either raising or lowering them if you pay your bills on time every month and do not max out a credit card or line of credit the lender may increase your credit limit 4an increased credit limit has a number of benefits including potentially increasing your credit score by lowering your credit utilization ratio it also gives you access to more credit if you should need it such as in an unexpected emergency on the other hand if you fail to make regular timely payments or if there are other signs of risk the lender may opt to reduce your credit limit a reduction of your credit limit will raise your credit utilization ratio and potentially damage your credit score if a lender decides to lower your credit limit it is generally required to notify you 4 | |
what is available credit | available credit is the unused portion of a credit limit so if you have a total credit limit of 10 000 on your credit card and you have used 5 000 you would have the remaining 5 000 as available credit available credit can fluctuate throughout the billing cycle based on account usage | |
what is a credit score | a credit score is a calculated value that serves as a proxy for your creditworthiness or ability and likelihood that you will repay any debts on time according to the terms of the loan agreement credit scores are generated based on information collected by credit reporting agencies such as experian equifax and transunion they use formulas that assign weights to factors like payment history amounts owed length of credit history and credit utilization | |
why does a credit limit matter | a credit limit matters because it dictates how much money you can access to pay for expenses you need to know your credit limit when you make purchases so you do not go over the limit and incur fees a merchant in that situation may also refuse to accept your card in addition your collective credit limits can impact your credit score which is based in part on how much of your available credit you are using at any given time the bottom linecredit limits can play a key role in your financial picture and they are different for each person and for each financial product if you use your credit according to your lender s terms and avoid exceeding or even coming too close to your limits you are more likely to establish a good credit history which can open up other financial opportunities | |
what is a credit linked note | a credit linked note cln is a security with an embedded credit default swap permitting the issuer to shift specific credit risk to credit investors credit linked notes are created through a special purpose vehicle spv or trust which is collateralized with aaa rated securities investors buy credit linked notes from a trust that pays a fixed or floating coupon during the life of the note in return for accepting exposure to specified credit risks investors who buy credit linked notes typically earn a higher rate of return compared to other bonds 1understanding credit linked notes cln based on the fact that credit linked notes are backed by specified loans there is an innate risk of default associated with the security to create a credit linked note a loan must be issued to a customer meanwhile an institution may choose to hold the loan and earn income based on interest payments received as the loan is repaid or it may sell the loan to another institution in the latter option loans are sold to an spv or trust which ultimately divides the loan into various parts often bundling similar parts together based on the overall risk or rating the bundled parts are used to create securities that investors can purchase at maturity the investors receive par unless the referenced credit defaults or declares bankruptcy in which case they receive an amount equal to the recovery rate the trust enters into a default swap with a deal arranger credit linked notes as investmentsa credit linked note functions similarly to a bond in that payments are made semi annually but with a credit default swap attached the spv or trust pays the dealer par minus the recovery rate in exchange for an annual fee which is passed on to the investors in the form of a higher yield on the notes under this structure the coupon or price of the note is linked to the performance of a reference asset it offers borrowers a hedge against credit risk and gives investors a higher yield on the note for accepting exposure to a specified credit event special considerationsthe use of a credit default swap allows the risk associated with default to be sold to other parties and provides a function similar to insurance investors generally receive a higher rate of return than on other bonds as compensation for the additional risk associated with the security in case of default all involved parties including the spv or trust investors and at times the original lender are at risk for losses the amount of loss experienced will vary depending on the number of loans or parts of loans present in the security how many of the associated loans end up in default and how many investors are participating in the particular security packages | |
what is a credit rating | a credit rating is an independent assessment of the ability of a corporation or a government to repay a debt either in general terms or regarding a specific financial obligation credit scores are assigned to individuals based on their personal history of acquiring and repaying debt they are checked by lenders considering loaning money to a consumer credit ratings are issued to companies and governments by several companies including s p global moody s and fitch ratings credit ratings are used by investors who want to know the risk of buying bonds or other debt instruments issued by these entities understanding credit ratingscredit ratings are an estimate of the level of risk involved in lending money to a business or other entity including national and state governments and government agencies a high credit rating indicates that in the rating agency s opinion a bond issuer is likely to repay its debts to investors without difficulty a low credit rating suggests it might struggle to make its payments the lowest ratings indicate the borrower is in real financial trouble bonds receive credit ratings before they are issued the interest they pay is based on the credit rating they receive a lower rated company is forced to pay a higher interest rate to compensate for the risk of the investment investors and lenders use credit ratings to decide whether to do business with the rated entity and to determine how much interest they would expect to receive to compensate them for the risk involved 1credit rating agencies typically assign letter grades to the entities they rate s p global for instance has a bond credit rating scale ranging from aaa excellent down to c and d moody s scale ranges from aaa to c 45credit ratings also reflect different time horizons short term credit ratings reflect the likelihood that a borrower will default on a debt within the year this type of credit rating has become the norm in recent years whereas long term credit ratings were more influential in the past long term credit ratings predict the borrower s likelihood of defaulting at any given time in the extended future 5a brief history of credit ratingscredit ratings date back to the early 20th century they became particularly influential after 1936 when federal banking regulators issued rules prohibiting banks from investing in speculative bonds bonds with low credit ratings the aim was to avoid the risk of default which could lead to financial losses and even bank failures other companies and financial institutions quickly adopted this practice relying on credit ratings became the norm 6the major credit rating agenciesthe global credit rating industry is highly concentrated with three agencies controlling most of the market moody s s p global and fitch ratings all three are nationally recognized statistical rating organizations nrsros overseen by the u s securities and exchange commission here is a quick overview of each john knowles fitch founded the fitch publishing company in 1913 providing financial statistics for the investment industry via the fitch stock and bond manual and the fitch bond book in 1924 fitch introduced an aaa through d rating system 7nearly a century later fitch ratings employs more than 1 550 analysts in 36 global offices 8john moody first published moody s manual of industrial and miscellaneous securities in 1900 the manual provided basic statistics and general information about stocks and bonds of companies in several industries but it did not rate them 9in 1909 moody began publishing moody s analyses of railroad investments and for the first time rated many railway company securities 10 five years later moody began offering similar ratings for public utilities and other industries 11today moody s investors service is a global enterprise with more than 40 offices providing ratings and research on companies and governments across the world 12s p global s roots date to 1860 when henry varnum poor published the history of railroads and canals in the united states providing investors with data on the railway industry nearly half a century later in 1906 luther lee blake launched the standard statistics bureau which offered similar data on companies in other industries 13poor s publishing issued its first credit ratings in 1916 and standard statistics followed in 1922 the two organizations merged in 1941 to form standard poor s corporation 13standard poor s corporation was acquired by the mcgraw hill companies in 1966 and the company rebranded as s p global in 2016 today s p global has more than 70 offices in 35 countries 14importance of credit ratingscredit ratings are important not only for prospective investors but for the entities that they rate a high rating can give a company or government access to the capital it needs at interest rates it can afford a low one can mean that the borrower has to pay much higher rates if it can access capital at all the entities themselves typically request that they or the securities they issue be rated and they pay the rating agencies for doing so 15credit ratings scalewhile each rating agency uses a slightly different scale they assign ratings as letter grades in general a rating of aaa is the highest possible credit rating while a c or d rating is the lowest 3the rating scales for long term debt at the three leading agencies are illustrated below there can be further divisions in each letter rating for example s p assigns a or for ratings between ccc and aa indicating a slightly higher or lower level of creditworthiness for moody s the distinction is made by adding a number between 1 and 3 a baa2 rating is slightly better than a baa3 and slightly worse than a baa1 21all three credit rating agencies divide their ratings into two general categories based on their assessed level of risk for s p global ratings of bbb and higher are considered investment grade while grades of bb and lower are considered speculative 5 for moody s baa3 and up is investment grade while ba1 and below is non investment grade 2 with fitch bbb and higher is investment grade with bb and lower being speculative 16factors that go into credit ratingscredit rating agencies consider a wide range of factors in forming their opinions and each has its own formula in general the major factors that influence the credit rating are note that credit ratings involve some judgment calls on the part of the agency and are subject to change even an entity with a spotless payment history can be downgraded if the rating agency believes its ability to make repayments will be impaired 15 | |
what s the difference between a credit rating and a credit score | the terms are often used interchangeably but a credit rating evaluates a company s or government s ability to repay a debt while credit scores are assigned to individual consumers their functions are quite similar both credit ratings and credit scores are used by lenders being asked to loan money as an indication of the risk of the deal | |
what does a credit rating tell an investor | a credit rating is an educated opinion about the financial health of a business or government it is a conclusion of the likelihood that the business or government will be able to repay its debts investors use that information when deciding whether to buy bonds issued by that entity and whether they will be adequately compensated for the risk involved investors also compare the ratings of various bonds when deciding which to buy 15 | |
what is a nationally recognized statistical rating organization | nationally recognized statistical rating organizations nrsros are credit rating agencies that are overseen by the office of credit ratings ocr in the u s securities and exchange commission the ocr was created by the dodd frank wall street reform and consumer protection act in the wake of the financial crisis of 2007 2008 to enhance the regulation accountability and transparency of the credit rating agencies 17there are currently 10 nrsros of which the largest are fitch ratings moody s investors service and s p global ratings 18the bottom linecredit ratings are the corporate or government counterparts of personal credit scores for individuals they provide useful information to prospective investors and lenders but as the rating agencies themselves stress represent an informed judgment of potential risk not an absolute guarantee 15 | |
what is a credit report | a credit report is a detailed breakdown of your credit history prepared by a credit bureau credit bureaus collect financial information about you and compile their reports based on that information lenders use the reports often along with other data to determine your creditworthiness insurance companies employers and landlords may check your credit reports as well | |
how credit reports work | in the united states there are three major credit reporting bureaus equifax experian and transunion each of these companies collects information about your credit history to create a unique credit report on you although most of their information is similar there are often small differences among the three reports depending on which of your creditors such as mortgage lenders and credit card companies provide information to that particular bureau some creditors may supply information to one or two bureaus but not all three and some may not supply any information on you at all credit reports focus primarily on your use of credit they do not include information on other types of bills nor do they show your income investments or other assets derek notman cfp chfc cluintrepid wealth partners llc madison wimake sure to review your credit report before you need it a client of mine was applying for a home mortgage and when the bank pulled their credit report there was over 20 000 of credit card debt on the report but the client didn t have any credit cards | |
what had happened was that the client had the same name as their father so when the credit report was run it pulled their correct information but also accidentally pulled their father s credit card balance | make sure to check for errors before you think you will need to apply for credit so you can have them fixed if there are any not doing this could delay your credit decision cause your lender to think twice about lending you credit and ultimately delay a time sensitive purchase | |
what information is in my credit report | credit reports typically divide information into four sections these are 2credit reports and credit scorescredit scores are three digit numbers typically ranging from 300 to 850 that serve as a sort of shorthand for your creditworthiness the information in your credit reports is used to compute your credit scores but the scores themselves are not part of your report and must be obtained separately credit scores are computed using formulas developed by fico or a competitor such as vantagescore they assign different weightings to the information in your credit report to reflect its importance and predictive value a typical fico score breaks down like this 3payment history 35 this reflects whether you pay your credit bills on time amounts owed 30 this looks at factors such as your credit utilization ratio which compares how much debt you have outstanding to the total amount of credit you have available to you generally speaking the lower that percentage the better length of credit history 15 older accounts count for more than newer ones credit mix 10 the credit scoring models favor individuals who ve had a variety of credit types such as a credit card and a car loan or mortgage and used them all responsibly new credit 10 if you ve taken on a lot of new credit lately lenders can see that as a red flag while that s a typical breakdown some scoring models put greater emphasis on certain factors for example there are scoring models specifically for mortgage lenders car loan lenders and credit card issuers as a result many consumers won t have just one credit score but several of them | |
how long does information remain on your credit report | information on your credit report will typically remain for at least seven years after which it basically falls off one exception is chapter 7 bankruptcy which can remain for up to 10 years 4who can see your credit report under the fair credit reporting act businesses and other parties need a legally permissible reason to request your credit report that list can include lenders insurance companies employers landlords and government agencies in the case of employers you must give your permission in writing 5 | |
how can you obtain your credit report | by law you are entitled to a free copy of your credit report from each of the three major bureaus at least once a year the official website for that purpose is annualcreditreport com you re also entitled to see your credit report free of charge if you ve recently been denied credit insurance or employment based on the information in your report or if you ve been a victim of identity theft 1the bottom lineyour credit reports contain information that lenders insurance companies and others will use to judge you for that reason it s important to check your reports periodically to make sure the information in them is correct if you find errors you have a right to dispute them and the credit bureau is required by law to investigate the matter and get back to you | |
what is credit risk | credit risk is the probability of a financial loss resulting from a borrower s failure to repay a loan essentially credit risk refers to the risk that a lender may not receive the owed principal and interest which results in an interruption of cash flows and increased costs for collection lenders can mitigate credit risk by analyzing factors about a borrower s creditworthiness such as their current debt load and income although it s impossible to know exactly who will default on obligations properly assessing and managing credit risk can lessen the severity of a loss interest payments from the borrower or issuer of a debt obligation are a lender s or investor s reward for assuming credit risk 1investopedia theresa chiechiunderstanding credit risk | |
when lenders offer mortgages credit cards or other types of loans there is a risk that the borrower may not repay the loan similarly if a company offers credit to a customer there is a risk that the customer may not pay their invoices 3 | credit risk can describe the chance that a bond issuer may fail to make payment when requested or that an insurance company will be unable to pay a claim 4credit risks are calculated based on the borrower s overall ability to repay a loan according to its original terms to assess credit risk on a consumer loan lenders often look at the five cs of credit credit history capacity to repay capital the loan s conditions and associated collateral 2some companies have established departments responsible for assessing the credit risks of their current and potential customers technology has allowed businesses to quickly analyze data used to determine a customer s risk profile bond credit rating agencies such as moody s investors services and fitch ratings evaluate the credit risks of corporate bond issuers and municipalities and then rate them if an investor considers buying a bond they will often review the credit rating of the bond if a bond has a low rating bbb the issuer has a relatively high risk of default conversely if it has a stronger rating bbb a aa or aaa the risk of default is lower 56credit risk vs interest ratesif there is a higher level of perceived credit risk investors and lenders usually charge a higher interest rate 3creditors may decline a loan to a borrower they perceive as too risky for example a mortgage applicant with a superior credit rating and steady income is likely to be perceived as a low credit risk so they will likely receive a low interest rate on their mortgage in contrast an applicant with a poor credit history may have to work with a subprime lender to get financing 3the best way for a high risk borrower to get lower interest rates is to improve their credit score if you have poor credit consider working with a credit repair company 7similarly bond issuers with less than perfect ratings offer higher interest rates than those with perfect credit ratings the issuers with lower credit ratings use high returns to entice investors to assume the risk associated with their offerings 8 | |
how do banks manage credit risk | banks can manage credit risk with several strategies they can set specific standards for lending including requiring a certain credit score from borrowers then they can regularly monitor their loan portfolios assess any changes in borrowers creditworthiness and make any adjustments 9 | |
what are the five cs of credit | the five cs of credit include capacity capital conditions character and collateral these are the factors that lenders can analyze about a borrower to help reduce credit risk performing an analysis based on these factors can help a lender predict the likelihood that a borrower will default on a loan 10 | |
how do lenders measure the five cs of credit | each lender will measure the five cs of credit capacity capital conditions character and collateral differently generally lenders emphasize a potential creditor s capacity or the amount of income they have relative to the debt they are carrying 10the bottom linecredit risk is a lender s potential for financial loss to a creditor or the risk that the creditor will default on a loan lenders consider several factors when assessing a borrower s risk including their income debt and repayment history when a lender sees you as a greater credit risk they are less likely to approve you for a loan and more likely to charge you higher interest rates if you do get approved 3 | |
what is credit risk | credit risk is the probability of a financial loss resulting from a borrower s failure to repay a loan essentially credit risk refers to the risk that a lender may not receive the owed principal and interest which results in an interruption of cash flows and increased costs for collection lenders can mitigate credit risk by analyzing factors about a borrower s creditworthiness such as their current debt load and income although it s impossible to know exactly who will default on obligations properly assessing and managing credit risk can lessen the severity of a loss interest payments from the borrower or issuer of a debt obligation are a lender s or investor s reward for assuming credit risk 1investopedia theresa chiechiunderstanding credit risk | |
when lenders offer mortgages credit cards or other types of loans there is a risk that the borrower may not repay the loan similarly if a company offers credit to a customer there is a risk that the customer may not pay their invoices 3 | credit risk can describe the chance that a bond issuer may fail to make payment when requested or that an insurance company will be unable to pay a claim 4credit risks are calculated based on the borrower s overall ability to repay a loan according to its original terms to assess credit risk on a consumer loan lenders often look at the five cs of credit credit history capacity to repay capital the loan s conditions and associated collateral 2some companies have established departments responsible for assessing the credit risks of their current and potential customers technology has allowed businesses to quickly analyze data used to determine a customer s risk profile bond credit rating agencies such as moody s investors services and fitch ratings evaluate the credit risks of corporate bond issuers and municipalities and then rate them if an investor considers buying a bond they will often review the credit rating of the bond if a bond has a low rating bbb the issuer has a relatively high risk of default conversely if it has a stronger rating bbb a aa or aaa the risk of default is lower 56credit risk vs interest ratesif there is a higher level of perceived credit risk investors and lenders usually charge a higher interest rate 3creditors may decline a loan to a borrower they perceive as too risky for example a mortgage applicant with a superior credit rating and steady income is likely to be perceived as a low credit risk so they will likely receive a low interest rate on their mortgage in contrast an applicant with a poor credit history may have to work with a subprime lender to get financing 3the best way for a high risk borrower to get lower interest rates is to improve their credit score if you have poor credit consider working with a credit repair company 7similarly bond issuers with less than perfect ratings offer higher interest rates than those with perfect credit ratings the issuers with lower credit ratings use high returns to entice investors to assume the risk associated with their offerings 8 | |
how do banks manage credit risk | banks can manage credit risk with several strategies they can set specific standards for lending including requiring a certain credit score from borrowers then they can regularly monitor their loan portfolios assess any changes in borrowers creditworthiness and make any adjustments 9 | |
what are the five cs of credit | the five cs of credit include capacity capital conditions character and collateral these are the factors that lenders can analyze about a borrower to help reduce credit risk performing an analysis based on these factors can help a lender predict the likelihood that a borrower will default on a loan 10 | |
how do lenders measure the five cs of credit | each lender will measure the five cs of credit capacity capital conditions character and collateral differently generally lenders emphasize a potential creditor s capacity or the amount of income they have relative to the debt they are carrying 10the bottom linecredit risk is a lender s potential for financial loss to a creditor or the risk that the creditor will default on a loan lenders consider several factors when assessing a borrower s risk including their income debt and repayment history when a lender sees you as a greater credit risk they are less likely to approve you for a loan and more likely to charge you higher interest rates if you do get approved 3 | |
savvy investors know that credit spreads may be one of the best indicators of the broader economy s health not just the creditworthiness of this or that company in bond trading the difference between the yields of two bonds with the same maturity but different credit quality is known as the credit spread and it can have a significant effect on your investment returns | credit spreads are measured in basis points which are equal to 0 01 for example a 1 difference in yield is equal to a spread of 100 basis points also known as bond yield or default spreads they allow you to quickly compare the yields of corporate bonds to risk free alternatives such as treasury notes for instance if a 10 year treasury note yields 5 and a 10 year corporate bond yields 7 the credit spread between the two bonds is 200 basis points analysts also aggregate all corporate bonds of a particular type subtract out the treasury rates and assess the expectations for the broader economic climate wider yields portend a dire outlook while narrowing yields indicate economic optimism it s important to note that credit spreads also refer to an options trading strategy in that context a credit spread concerns writing a high premium option and buying a low premium option on the same underlying asset which results in a credit to the account of the person making the two trades below we take you through how to calculate credit spreads and why they re essential when investing investopedia jake shibond credit spreadsa bond credit spread also known as a yield spread is the difference in yield between two bonds with similar maturities but different credit qualities it is a measure of the additional yield that investors demand for holding a bond with a higher perceived credit risk than a safer bond such as a government bond or a high quality aaa rated corporate bond over a junk bond 1the bond credit spread is typically given in basis points bps where 1 bp equals 0 01 for instance if bond a has a yield of 5 and bond b has a yield of 4 the credit spread between them is 100 bps or 1 bond credit spreads are often used to gauge the market s perception of the creditworthiness of a particular issuer or sector a wider credit spread means that investors perceive a higher risk of default and require a higher yield to compensate for that risk conversely a narrower credit spread suggests that investors are more confident in the issuer s ability to meet its debt obligations and are willing to accept a lower yield here are a few examples of bond credit spreads investors analysts and policymakers closely monitor bond credit spreads since they provide valuable insights into market sentiment risk perception and the overall health of the bond market changes in credit spreads also have implications for borrowing costs investment strategies and economic growth interpreting bond yield spreads for economic healththe yield spread between corporate bonds and 10 year treasury bonds has long been seen as a crucial indicator of economic conditions and investor sentiment yield spreads reflect the additional compensation investors require for taking on the risk of corporate bonds over the relatively risk free treasurys in typical economic conditions the spread between high quality corporate bonds such as those rated aaa and 10 year treasurys typically ranges from 1 to 2 for lower quality corporate bonds such as bbb rated bonds the spread is usually higher ranging from 2 to 4 or more these spreads provide greater insight into investor sentiment about the economy than many other economic indicators interpreting yield spreadsa narrow yield spread close to 1 suggests that investors are confident in the economic outlook and believe that the risk of corporate defaults is low this is often seen during strong economic conditions where investors are willing to accept lower premiums for holding corporate debt meanwhile a widening yield spread indicates increased concern about the economy as investors become more risk averse they demand higher yields on corporate bonds to compensate for the perceived higher risks of default the worse the economy the more corporations are likely to default on their borrowing as you can see from the chart below widening spreads signal economic uncertainty a potential downturn or a grave and vast crisis as with the bond yield spread spikes after the events of sept 11 2001 the 2007 to 2008 financial crisis and the pandemic when economic jitters if not panic were felt in the bond markets and beyond yield spreads moving closer to and below 1 0 show greater confidence in the broad economy the credit spread of a bond is a measure of the additional yield that investors demand for holding a bond that s a higher credit risk it can be approximated using the formula in this formula the recovery rate represents the percentage of the investment that investors expect to recover in the event of a default while the default probability represents the likelihood of the issuer not paying its debt obligations the term 1 recovery rate represents the expected loss given default which is then multiplied by the probability of default to estimate the overall expected loss for the bond the expected loss serves as a proxy for the credit spread as investors would require a higher yield to compensate for the potential loss however this formula is a simplification and doesn t account for all the factors that influence credit spreads such as liquidity risk market sentiment and the specific cash flow characteristics of the bond credit spreads are larger for riskier debts such as those issued by emerging markets and lower rated corporations than by government agencies and wealthier and or stable nations spreads are larger for bonds with longer maturities calculating a credit spread between bonds and treasurysa credit spread is often used to report the difference in yield between a treasury and corporate bond of the same maturity this is because bonds issued by the u s government are considered risk free the spread thus reflects the added compensation investors require for assuming the higher default risk of corporate bonds compared with risk free government bonds the formula for calculating credit spread between bonds is as follows let s say we want to calculate the credit spread for a 10 year corporate bond issued by abc corporation the bond yields 5 and the yield on a 10 year treasury is 3 subtract the treasury bond yield from the corporate bond yield in this example the credit spread is 2 or 200 basis points as such investors require 2 additional percentage points in yield to hold abc corporation s bonds over holding risk free 10 year treasury bonds a higher credit spread means that the market perceives the corporate bond as having a higher risk of default a lower credit spread suggests that the corporate bond is considered safer there are bond market indexes that investors and financial experts use to track the yields and credit spreads of different types of debt with maturities ranging from three months to 30 years some of the most important indexes include high yield and investment grade u s corporate debt mortgage backed securities tax exempt municipal bonds and government bonds credit spreads in options tradinga credit spread can also refer to a type of options strategy where the trader buys and sells options of the same type and expiration but with different strike prices in this context bond yields are not involved in a credit spread involving options the premiums received should be greater than the premiums paid resulting in a credit for the trader the net credit is the maximum profit a trader can make two such strategies are the bull put spread where the trader expects the underlying security to go up and the bear call spread where the trader expects the underlying security to go down an example of a credit spread that could be a bear call spread would include buying a january 50 call on abc for 2 and writing a january 45 call on abc for 5 let s break this down your profit or loss depends on the price of abc stock at expiration this strategy is called a credit spread because the trader receives a net credit for entering the position | |
what is the difference between baa and aaa bonds | the primary difference between baa and aaa bonds lies in their credit ratings and associated risk levels baa bonds are rated as medium grade investments by moody s investors service they are considered to be of moderate credit quality meaning they carry a higher risk of default than higher rated bonds but are still investment grade baa bonds offer higher yields to compensate for the increased risk aaa bonds are rated as high quality investments they are considered to be of the highest credit quality with a very low risk of default aaa bonds are highly stable and offer lower yields because of their lower risk profile | |
how does credit spread affect bond price | the credit spread is the result of the difference in risk corporate bonds come with more risk than u s treasury bonds so they need to offer higher yields to attract investors the price you pay for either bond may be the same but you are assuming a higher risk with corporate bonds which means you have the potential to earn more can you lose money on a credit spread as with any investment strategy there is risk and the possibility that you could lose money on a credit spread you could lose money if the premiums received are less than the premiums paid the bottom linea credit spread is relatively straightforward the difference in yield between two debt securities that mature simultaneously but have different risks bonds with higher risks typically have higher yields the term credit spread also refers to a strategy that involves purchasing one option while selling another similar option with a different strike price the yield spread between corporate bonds and 10 year treasurys is vital for gauging economic health and investor sentiment a good yield spread depends on perceptions about economic conditions with narrow spreads indicating confidence and stability while widening spreads suggest increased concern about economic risks by understanding and interpreting these spreads investors can gain valuable insights into the economy and make more informed investment decisions | |
what is a credit union | a credit union is a type of financial cooperative that provides traditional banking services ranging in size from small volunteer only operations to large entities with thousands of participants spanning the country credit unions can be formed by large corporations organizations and other entities for their employees and members credit unions are created owned and operated by their members as such they are not for profit enterprises that are accorded tax exempt status understanding a credit unioncredit unions follow a basic business model members pool their money technically they are buying shares in the cooperative to provide loans demand deposit accounts and other financial products and services to each other any income generated is used to fund projects and services that will benefit the community and the interests of members originally membership in a credit union was limited to people who shared a common bond they may have worked in the same industry or for the same company or they may have lived in the same community however credit unions have loosened the restrictions on membership and often allow the general public to join to do any business with a credit union you must join it by opening an account there often for a nominal amount as soon as you do you become a member and partial owner that means you participate in the union s affairs you may vote to determine the board of directors and decisions concerning the union a member s voting right is not based on how much money is in their account each member gets an equal vote according to the national credit union administration ncua membership in federally insured credit unions grew to 136 6 million as of march 31 2023 1total assets in federally insured credit unions as of march 31 2023 were 2 21 trillion 1advantages of credit unions vs banksas with banks the process of making money at credit unions starts by attracting deposits in this credit unions have two distinct advantages over banks both resulting from their status as nonprofit organizations the profits that credit unions do make are used to pay members higher interest rates on deposits and to charge lower fees for services such as checking accounts and atm withdrawals in short a credit union can save members money on loans deposit accounts and savings products according to ncua data as of march 31 2023 the national average rate for five year certificates of deposit cds offered by credit unions was 2 66 compared to an average rate of 1 83 offered by banks 2money market rates at credit unions were also higher with an average rate of 0 53 versus the average bank rate of 0 43 2while these differences sound small they do add up giving credit unions a significant advantage over banks when competing for deposits credit unions provide better rates on most mortgages including 15 year and 30 year fixed mortgages which could be a good option if you are looking to purchase a home 2 disadvantages of credit unions vs bankscredit unions have considerably fewer brick and mortar locations than most banks which can be a drawback for clients who like in person service most offer modern services such as online banking and auto bill pay still the small size of many credit unions can mean a compromise on accessibility smaller credit unions typically do not have the same technology budget as banks so their websites and security features are often considerably less advanced that said some mid sized and larger credit unions may offer mobile banking apps that rival those of much bigger for profit institutions while credit unions offer most of the financial products and services that banks do they often provide less choice bank of america has 20 different credit card options ranging from rewards cards to student cards while the navy federal credit union nfcu has only six 34 the second largest credit union in the country the state employees credit union secu offers one credit card 56with more resources to allocate to customer service and personnel banks are keeping later and longer hours you may find them open until 5 p m or 6 p m on weekdays and often on saturdays as well credit unions tend to maintain traditional bankers business hours 9 a m to 3 p m monday through friday though the larger ones such as secu have a 24 hour customer service hotline insurance on credit union accountsthe federal deposit insurance corporation fdic does not cover credit unions however the ncua established in 1934 and which regulates federally chartered credit unions and most state chartered credit unions does provide account protection 7in fact one of the ncua s main responsibilities is to administer the national credit union share insurance fund ncusif which uses federal monies to back up shares deposits in all federal credit unions the ncua provides coverage for each individual account joint account trust account retirement account such as traditional iras roth iras or keogh plan accounts and business account for up to 250 000 per account 7for example if you have an individual account a roth ira and a business account at a credit union your total shares are insured up to 750 000 you can research credit unions of interest that the ncua regulates at the ncua website | |
what benefits do credit unions offer | normally credit unions offer higher rates on interest bearing accounts lower rates on loans lower fees and a more personal touch when it comes to customer service can anyone join a credit union nowadays you ll find more credit unions offering membership to all some still have specific eligibility requirements though so be sure to check out a credit union s field of membership section on its website for details about joining | |
how do i join a credit union | once you ve located a credit union that interests you you should be able to find membership specifics and an application to join on its website the application usually requires the kind of personal information related to opening a financial account which is what you re doing as part of applying for membership you ll then need to make a deposit to fund the account you ve chosen the bottom linecredit unions are significantly smaller in size than most banks and are structured to serve a particular region industry or group and though they may have fewer branches they can still provide customers ample access to their funds as many credit unions are part of expansive atm networks while credit unions must make enough to cover their operations any profit beyond that goes back to the members in the form of lower fees and account minimums higher rates on deposits and lower borrowing rates | |
what is a creditor | a creditor is an individual or institution that extends credit to another party to borrow money usually by a loan agreement or contract creditors are commonly classified as personal or real those who loan money to friends or family or a business that provides immediate supplies or services to a company or individual but allows for a delay in payment may be considered personal creditors real creditors are banks or finance companies that have legal contracts and loan agreements with the borrower that grant the lender the right to claim any of the debtor s real assets or collateral if the loan is unpaid understanding creditorscreditors often charge interest on the loans they offer their clients such as a 5 interest rate on a 5 000 loan the interest represents the borrower s cost of the loan and the creditor s degree of risk that the borrower may not repay the loan to mitigate risk most creditors tie interest rates or fees to the borrower s creditworthiness and past credit history borrowers with good credit scores are considered low risk to creditors and these borrowers often garner low interest rates in contrast borrowers with low credit scores are riskier for creditors and are often charged higher interest rates to address that risk while the creditor is the entity that extends credit a debtor is the legal party that accepts the credit or loan owes the debt and agrees to its repayment | |
what happens if creditors are not repaid | secured creditors often a bank or mortgage company have a legal right to reclaim the property such as a car or home used as collateral for a loan often through a lien or repossession an unsecured creditor such as a credit card company is a creditor where the borrower has not agreed to give the creditor any property such as a car or home as collateral to secure a debt these creditors may sue these debtors in court over unpaid unsecured debts and courts may order the debtor to pay garnish wages issue a bank levy or take other actions creditors and bankruptcybankruptcy is a legal process through which individuals who cannot repay debts to creditors may seek relief from some or all of their debts bankruptcy is initiated by the debtor and is imposed by a court order |
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