Electronic copy available at: http://ssrn.

com/abstract=1447750
1




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! )/012 34 #5/678/076
39
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)0>?5//61 @2AB

AdlLya Slngal (CuLC 08 l8 001)
San[ana aLhl (CuLC 08 WM 034)








Electronic copy available at: http://ssrn.com/abstract=1447750
2





!::;561 76=687<C "73D6</
39
! =/012 34 ;5/678/076 39 *37:378/6 &6480;/ "7615</37=
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@0=596== !1?595=/78/539 HFG@!I



Subm|tted 8y
AdlLya Slngal (CuLC 08 l8 001)
San[ana aLhl (CuLC08 WM 034)




Under the Gu|dance of:-
Mr. Lsmond L. C. Choo (Company MenLor)
ur. arvlnder Arora (College MenLor)
rof. vlnlka 8ao (College MenLor)
Electronic copy available at: http://ssrn.com/abstract=1447750
3


!<J93K;61L6?69/

We would llke Lo Lhank ur. arvlnder Arora, our resldenL flnance faculLy aL S !aln CenLer of
ManagemenL, Slngapore campus, and Mr. Lsmond L. C. Choo, LxecuLlve ulrecLor, uC8 kA? Plan rlvaLe
LlmlLed who have menLored ln our Applled 8esearch ro[ecL. 1helr guldance was cruclal Lo glve Lhe
deflnlLlve dlrecLlon Lo Lhls research and Lo brlng lL Lo a concluslon, whlch can be presenLed for Lhe sLudy
of LlLeraLure on CorporaLe uefaulL redlcLors
We would also llke Lo Lhank rof. vlnlka 8ao and Mr. Sandlp ChakroborLy for Lhelr acLlve lnvolvemenL
durlng our course of pro[ecL and helplng us wlLh necessary lnpuLs durlng Lhe sLudy and gaLherlng of Lhe
daLa for Lhe pro[ecLs.
We also Lhank all Lhe faculLles who helped us ln undersLandlng many concepLs whlch we applled durlng
Lhe course of Lhls sLudy
4


&6<;878/539

We hereby declare LhaL Lhe maLLer lncluded ln Lhls Applled 8esearch ro[ecL enLlLled Study of L|terature
on Corporate Defau|t red|ctors" ls Lhe resulL of sLudy carrled ouL by us. We furLher declare LhaL Lhls ls
our orlglnal work and has noL been publlshed anywhere before. 1hls ro[ecL work has been carrled ouL
for Lhe sole purpose of submlsslon ln parLlal fulfllmenL of Clobal MasLers ln 8uslness ManagemenL
(CM8A) aL S !aln CenLer of ManagemenL, Slngapore.





Name and S|gnature of the Student:


Ad|tya S|nga|
(CuLC 08 l8 001)
lnvesLmenL 8anklng SpeclallsaLlon
S !aln CenLer of ManagemenL
10, Pyderabad 8oad, Cff Alexandra 8oad







San[ana ath|
(CuLC 08 WM 034)
WealLh ManagemenL SpeclallsaLlon
S !aln CenLer of ManagemenL
10, Pyderabad 8oad, Cff Alexandra 8oad


ro[ect Mentor:
Mr. Lsmond L. G. Choo. (Company MenLor)
Dr. arv|nder Arora (College MenLor)
rof. V|n|ka kao (College MenLor)


3

1ab|e of Content


lnLroducLlon................................................................................................................................................... 6
Cb[ecLlves ...................................................................................................................................................... 7
Scope ............................................................................................................................................................. 7
uefaulL redlcLlon Models ............................................................................................................................. 7
8evlew: Z-Score model .................................................................................................................................. 8
Macro Lconomlc LffecLs on CorporaLe defaulLs .......................................................................................... 12
MerLon's Model for valulng a company ...................................................................................................... 14
kMv-MerLon CredlL MonlLor Model............................................................................................................ 16
SLudy - lmpacL of Macro varlables .............................................................................................................. 21
AppllcaLlon of Lhe AlLman Z-Score Model.................................................................................................... 26
Cff-balance SheeL 1ransacLlons ................................................................................................................... 36
8eferences ................................................................................................................................................... 42
Appendlx...................................................................................................................................................... 44









6

$9/7310</539

WlLh Lhe recenL hlsLorlc melLdown of global economles, wlLh some of Lhe long sLandlng and flrms of
repuLe faclng closure due Lo economlc fallure a need has come for exlsLlng buslnesses Lo sLarL Laklng
prevenLlve measures ln order Lo save Lhemselves of Lhe pllghL suffered by some of Lhe mosL lllusLrlous
companles of Lhe world. ln order Lo do Lhls, companles musL sLarL Lo reLrospecL Lhelr lnLernal rlsk
managemenL sysLems ob[ecLlvely and sub[ecLlvely, lendlng and lnvesLmenL pollcles prevlously adopLed by
Lhem. Moreover we see a growlng Lrend of caplLal provlders adopLlng a caplLal preservaLlon model over
Lhe growLh model and accounLlng for defaulL rlsk ln Lhelr model ls Lhe need of Lhe hour
ln Lhls reporL we wlll be explalnlng Lhe models and Lechnlques bullL have been developed by sLaLlsLlcal
and economlc experLs Lo predlcL flnanclal dlsLress over Lhe pasL 3 decades and use Lhe same ln ranklng
companles/lndusLrles ln order of Lhelr flnanclal healLh.
We have examlned Lhe mosL wldely used and relevanL predlcLlon models and Lechnlques of predlcLlng
defaulL of Lhe flrms Loday. MosL of Lhese models focus on Lhe fundamenLals of Lhe flrm's buslness. 1o
couple Lhls we have lncluded a model whlch lncludes Lhe fundamenLals of Lhe flrms wlLh Lhe
macroeconomlc varlables ln Lhe flrm's envlronmenL.
1he models we have dlscussed below have lncorporaLed Lhe fundamenLal rlsks of a buslness l.e. buslness
rlsk and flnanclal rlsks LhaL a flrm has Lo face and overcome for lLs long run survlval. 8elow ls a brlef
explanaLlon of Lhese rlsks:
8us|ness r|sk:
1hls ls a rlsk facLor or any clrcumsLance whlch mlghL bear a negaLlve lmpacL on Lhe operaLlons or Lhe
proflLablllLy LhaL Lhe flrm ls able Lo generaLe. 1hls rlsk can be lnherenL or can be a cause of exLernal
reasons. 1he buslness rlsks LhaL are lnherenL ln any company can be conLrolled by adopLlng sLrong rlsk
managemenL procedures and frameworks. 1hese rlsks are generally flrm speclflc and are classlfled as
unsysLemaLlc rlsks. 1he exLernal rlsks can be harder Lo conLrol and ls generally avolded ln buslnesses.
1hese rlsks also Lend Lo affecL Lhe lndusLry and Lherefore Lhe losses are dlsLrlbuLed among varlous flrms
and Lhe overall reLurn from an lndusLry drops ln such a case. 1hese rlsks can also be classlfled as markeL
or sysLemlc rlsks.
I|nanc|a| r|sk:
1hls ls Lhe rlsk LhaL ls a shareholder has Lo bear when Lhe company uses debL ln lLs flnanclng sLrucLure
and Lhe company ls noL able Lo generaLe enough cash flows Lo meeL lLs consLanL debL obllgaLlons.
Cenerally companles wlLh hlgh leverage run hlgh flnanclal rlsks. 1hls rlsk embodles Lhe axlom l.e. Lhe
greaLer Lhe reLurns one requlres Lhe greaLer Lhe rlsks one has Lo bear. 1he shareholder can geL greaLer
reLurns wlLh a larger leverage, buL a larger leverage dlrecLly lncreases Lhe proporLlon of flnanclal rlsk ln a
company
1he need for measur|ng r|sk
Lvery buslness unlL ls suscepLlble Lo varlous rlsks LhaL Lhe envlronmenL around lL holds. 1hese would
lncludes Lhe rlsks relaLed lL lLs operaLlons, Lhe caplLal sLrucLure, managerlal declslons, pollLlcal cllmaLe of
Lhe naLlon lL operaLes ln, changes ln Lhe demographlcs of lLs LargeL markeL, envlronmenLal hazards and
many more. arLles wlLh vesLed lnLeresL ln Lhe unlL expecL lL Lo manage mosL of Lhe rlsks LhaL fall wlLhln
lLs purvlew of 'manageable'. Some of Lhls lncludes Lhe buslness and flnanclal rlsk, as dlscussed above,
managerlal declslons whlch lnfluence Lhe course of buslness and operaLlons and largely Lhe rlsk due Lo
rlsks due Lo dynamlc LargeL markeLs. 1o manage Lhe laLLer rlsk, exLenslve markeL research and quallLaLlve
7

analysls of Lhe markeL, keeplng ln mlnd Lhe changlng preferences, needs Lo be done. 1he rlsk of Lhe
managemenL maklng a wrong declslon can be avolded uslng scenarlo analysls and oLher declslon maklng
Lools and prlnclpally by Lhe experlence Lhe managemenL has lnLrlnslcally.
1he sLudy observes how Lo measure Lhe buslness and Lhe flnanclal rlsks of a buslness and belng able Lo
quanLlfy lL wlLh Lhe ablllLy of predlcLlng Lhe fuLure course Lhe company would be forced Lo Lake lf lL ls noL
able Lo manage Lhese rlsks. 1he worsL case scenarlo of a company noL able Lo manage Lhese rlsks would
lead Lo Lhe company declarlng defaulL.
,>D6</5M6=
SLudy ls done ln order Lo achleve glven ob[ecLlves:
1o undersLand Lhe lmpacL of Lhe lnflaLlon raLe and lnLeresL raLe on Lhe defaulL probablllLy of Lhe
flrm
1o undersLand Lhe appllcaLlon of Lhe uefaulL predlcLlon model (Z Score) on Lhe companles wlLh
speclal relevance Lo SouLh LasL Aslan especlally for Lhe large markeLs ln Chlna, !apan, korea and
1alwan
1o undersLand Lhe off balance sheeL and how lL lmpacLs Lhe buslness.
)<3:6
1he scope of Lhe sLudy covered Lhe followlng polnLs:
8evlew of research papers ln order Lo Lrack Lhe evoluLlon of defaulL predlcLlon models ranglng
from Lhe Z- score model Lo Lhe recenL developmenLs of such as MerLon's model, LoglL 8egresslon
model eLc.,
1o undersLand Lhe appllcablllLy of such forecasLlng models Lo companles of parLlcular
secLors/reglons (lf any) for predlcLlng slgns of flnanclal dlsLress ln companles wlLh speclal
relevance Lo SouLh LasL Aslan especlally for Lhe large markeLs ln Chlna, !apan, korea and 1alwan,
1o lnclude slLuaLlonal case sLudles from lndusLrles such as alrllnes, auLomoblles, banklng and
reallLy secLor wlLh speclal focus Lo Lhe SouLh LasL Aslan markeLs
undersLandlng macro economlc facLors such as lnLeresL raLes, lnflaLlon, Cu CrowLh raLe eLc,
whlch affecL a flrm's lncldence of defaulL wlLh speclal relevance Lo Lhe currenL global scenarlo
1o evaluaLe Lhe lmpacL of 'off balance sheeL' lLems and LransacLlons on Lhe company,
&6480;/ "7615</539 G316;=
A company has numerous parLles who have vesLed lnLeresLs ln lLs susLalnablllLy and lLs ablllLy Lo meeL
obllgaLlons. lL ls because of Lhls under lylng concern LhaL Lhe 'golng concern' concepL made as a prlnclple
of accounLlng also. 1herefore Lo predlcL Lhe flnanclal healLh of a company one also has Lo look aL Lhe
amounL of dlsLress lL ls ln.
1here are 3 fundamenLal measures ln measurlng Lhe flnanclal dlsLress of a flrm. 1hese are unlvarlaLe,
mulLlvarlaLe and loglL analysls.

8

1hese models have been explalned ln Lhls sLudy lllusLraLlng Lhen wlLh pracLlcal examples perLlnenL Lo Lhe
SouLh LasL Aslan economles.
kev|ew: 2-Score mode|
Introduct|on

1he Z-Score was developed by Ldward l. AlLman ln 1968, an Amerlcan economlsL Lo reflne Lhe way
ordlnary flnanclal raLlos derlved from Lhe company's balance sheeLs and oLher flnanclal sLaLemenLs were
belng looked aL.
!"#$% '(")*+$+
1he raLlo analysls for companles ls generally done Lo calculaLe Lhe lnLernal sLrengLh and compare lL wlLh
an exLernal benchmark usually an lndusLry sLandard. 1hus Lhey are Lhe besL measure Lo compare Lhe rlsk
and reLurn relaLlonshlp ln any flrm. 1hese raLlos can be used Lo compare Lhe flrm agalnsL lLs pasL
performance or agalnsL Lhe lndusLry sLandard, Lhus enabllng Lhe lnvesLor Lo Lake an lnformed declslon.
1he prlmary advanLage of raLlo analysls ls LhaL lL ls easy for Lhe common person Lo comprehend and easy
Lo prepare. lL also provldes a common base for comparlson. 8uL Lhere were some lnherenL drawbacks ln
uslng raLlo analysls as a measure of Lhe flrm's sLablllLy. 1herefore AlLman developed Lhls model Lo reflne
Lhe way raLlos were belng used.
,-". /"01+ %2 -"#$% "(")*+$+
8aLlo analysls ls a unlvarlaLe meLhodology and Lhe resulL ls more on lndlvldual raLlos Lhan on Lhe
underlylng problems and ls generally suscepLlble Lo faulLy lnLerpreLaLlon. lor lnsLance, a flrm wlLh a poor
proflLablllLy and/or solvency record may be regarded as a poLenLlal bankrupL. Powever, because of lLs
above average llquldlLy, Lhe slLuaLlon may noL be consldered serlous
8aLlo analysls presenLed ln Lhls fashlon ls suscepLlble Lo faulLy lnLerpreLaLlon and ls poLenLlally confuslng.
Some of Lhe hlghllghLs of Lhe raLlo analysls are Laken as a base for Lhe Z score model. 1he quesLlons LhaL
need Lo be answered whlle formulaLlng Lhe Z- Score are:
1. Whlch raLlos are mosL lmporLanL ln deLecLlng bankrupLcy poLenLlal
2. WhaL welghLs should be aLLached Lo Lhose selecLed raLlos, and
3. Pow Lhe welghLs should be ob[ecLlvely esLabllshed.
,$+#$(0#$34 05"-"0#4-$+#$0+ %2 #54 6780%-4 9%:4)
Z-score uses mulLlple dlscrlmlnanL analysls (MuA), l.e. lL can conslder mulLlple characLerlsLlcs relevanL Lo
Lhe flrms and form a connecLlon among Lhem. 1herefore lL helps ln Lhe varlable proflle of Lhe ob[ecL
slmulLaneously raLher Lhan examlnlng lLs lndlvldual characLerlsLlcs one afLer anoLher. lL also reduces Lhe
dlmenslons and Lransforms Lhe analysls lnLo one dlmenslon uslng Lhe MuA Lechnlque, lL classlfles an
observaLlon lnLo one of several a ptlotl grouplngs dependenL upon Lhe observaLlon's lndlvldual
characLerlsLlcs. 1he Z-Score model ls a llnear analysls ln LhaL flve measures are ob[ecLlvely welghLed and
summed up Lo arrlve aL an overall score LhaL Lhen becomes Lhe basls for classlflcaLlon of flrms lnLo one of
Lhe a ptlotl grouplngs (dlsLressed and non-dlsLressed).


9

8"9;)4 84)40#$%(
ln Lhe sLudy conducLed by AlLman Lo LesL Lhe hypoLhesls of hls assumpLlon, a sample of 66 flrms was
selecLed and Lhe flrms were classlfled lnLo 2 groups of 33 each as dlsLressed and non dlsLressed flrms.
Croup 1- Lhe companles LhaL flled a bankrupLcy peLlLlon under ChapLer x of Lhe naLlonal 8ankrupLcy AcL
from 1946 Lhrough 1963.
Croup 2 conslsLs of a palred sample of manufacLurlng flrms chosen on a sLraLlfled random basls
1

1he flrms are sLraLlfled by lndusLry and by slze, lndusLry belng manufacLurlng wlLh Lhe asseL slze range
resLrlcLed Lo beLween $1 and $23 mllllon. 1he mean asseL slze of Lhe flrms ln Croup 2 ($9.6 mllllon)
AfLer Lhls selecLlon, each company's balance sheeL and lncome sLaLemenL was collecLed and a llsL of 22
raLlos were complled coverlng llquldlLy, proflLablllLy, leverage, solvency, and acLlvlLy
2
. 1here ls a LesL of
opLlmallLy, ln whlch all Lhe raLlos are puL Lhrough and afLer analyslng Lhe varlous alLernaLlves an opLlmum
mlx of 3 raLlos are arrlved. 1he followlng procedures are uLlllzed whlle arrlvlng aL Lhe raLlos:
1. CbservaLlon of Lhe sLaLlsLlcal slgnlflcance of varlous alLernaLlve funcLlons, lncludlng
deLermlnaLlon of Lhe relaLlve conLrlbuLlons of each lndependenL varlable,
2. LvaluaLlon of lnLer correlaLlons among Lhe relevanL varlables,
3. CbservaLlon of Lhe predlcLlve accuracy of Lhe varlous proflles, and
4. !udgmenL of Lhe analysL.
1he flnal dlscrlmlnanL funcLlon ls as follows:
Z = 1.2 + 1.4 + 3.3 + 0.6 + 1.0

Where, = worklng caplLal/LoLal asseLs,
= reLalned earnlngs/LoLal asseLs,
= earnlngs before lnLeresL and Laxes/LoLal asseLs,
= markeL value equlLy/book value of LoLal llablllLles,
= sales/LoLal asseLs, and
Z = overall lndex.
<54 3"-$"/)4+ "-4 :4+0-$/4: "+ 2%))%.+=
- Work|ng Cap|ta|]1ota| Assets (WC]1A).
Worklng caplLal ls deflned as Lhe dlfference beLween currenL asseLs and currenL llablllLles. LlquldlLy and
slze characLerlsLlcs are expllclLly consldered. Crdlnarlly, a flrm experlenclng conslsLenL operaLlng losses
wlll have shrlnklng currenL asseLs ln relaLlon Lo LoLal asseLs. 1he more popular measures of llquldlLy- l.e.
currenL and qulck raLlos were excluded slnce Lhey were found Lo be less helpful.

1
1he daLa ls arranged lnLo subseLs or sLraLa based on Lhe possesslon of cerLaln characLerlsLlcs whlch are common Lo
Lhe members of Lhe subseL. 1he selecLlon of unlLs Lo comprlse Lhe sample of Lhe parenL populaLlon ls arranged so
LhaL Lhe proporLlonal represenLaLlon of each subseL ln Lhe flnal sample flLs a prearranged schedule.

2
1he 8eaver sLudy (1967) concluded LhaL Lhe cash flow Lo debL raLlo was Lhe besL slngle raLlo predlcLor

10


- keta|ned Larn|ngs]1ota| Assets (kL]1A).
8eLalned earnlngs, ls also referred Lo as earned surplus. 8L/1A raLlo measures Lhe leverage of a flrm.
1hose flrms wlLh hlgh 8L, relaLlve Lo 1A, have flnanced Lhelr asseLs Lhrough reLenLlon of proflLs and have
noL uLlllzed as much debL. AnoLher polnL Lo noLe ln Lhls raLlo ls Lhe age of Lhe flrm. A relaLlvely new flrm
would noL have had Llme Lo conslderably bulld up lLs cumulaLlve proflLs. 1herefore, lL may be argued LhaL
Lhe young flrm ls somewhaL dlscrlmlnaLed agalnsL ln Lhls analysls, and lLs chance of belng classlfled as
bankrupL ls relaLlvely hlgher Lhan LhaL of anoLher older flrm, cetetls potlbos. 8uL, Lhls ls preclsely Lhe
slLuaLlon ln Lhe real world. 1he lncldence of fallure ls much hlgher ln a flrm's earller years. ln 1993,
approxlmaLely 30 of all flrms LhaL falled dld so ln Lhe flrsL flve years of Lhelr exlsLence

: Larn|ngs before Interest and 1axes]1ota| Assets (L8I1]1A)
1hls raLlo ls a measure of Lhe Lrue producLlvlLy of Lhe flrm's asseLs, lndependenL of any Lax or leverage
facLors. Slnce a flrm's ulLlmaLe exlsLence ls based on Lhe earnlng power of lLs asseLs, Lhls raLlo appears Lo
be parLlcularly approprlaLe for sLudles deallng wlLh corporaLe fallure, Lherefore Lhe largesL welghL has
been asslgned Lo Lhls dlscrlmlnanL slnce Lhls raLlo dlrecLly measure Lhe producLlvlLy of Lhe flrms
operaLlons.
lurLhermore, lnsolvency ln a bankrupL sense occurs when Lhe LoLal llablllLles exceed a falr valuaLlon of
Lhe flrm's asseLs wlLh value deLermlned by Lhe earnlng power of Lhe asseLs.

: Market Va|ue of Lqu|ty]8ook Va|ue of 1ota| L|ab|||t|es (MVL]1L).
LqulLy ls measured by Lhe comblned markeL value of all shares of sLock, preferred and common, whlle
llablllLles lnclude boLh currenL and long Lerm. 1he measure shows how much Lhe flrm's asseLs can decllne
ln value (measured by markeL value of equlLy plus debL) before Lhe llablllLles exceed Lhe asseLs and Lhe
flrm becomes lnsolvenL.

: Sa|es]1ota| Assets (S]1A)
1hls raLlo lllusLraLes Lhe sales generaLlng ablllLy of Lhe flrm's asseLs and shows Lhe managemenL's ablllLy
Lo produce reLurns even ln compeLlLlve condlLlons.
AfLer havlng deLermlned Lhe raLlos, AlLman reallsed a noLeworLhy dlfference beLween Lhe means of each
of Lhe raLlos for Lhe Lwo dlff sample groups:

1ab|e 1










1he means for Lhe raLlos for Lhe flrms ln Lhe non bankrupL group were a more conslsLenL Lhan Lhose
companles ln Lhe bankrupL group. 1hus Lhe lnlLlal valldlLy of Lhe sample ls belng esLabllshed Lhls way.
A Lrend analysls was also performed on Lhe lndlvldual raLlos ln Lhe model.
varlable
8ankrupL
group
mean
non
bankrupL
group mean
x1 -6.10 41.40
x2 -62.60 33.30
x3 -31.80 13.40
x4 40.10 247.70
x3 1.3x 1.9x
11

1he Lwo mosL lmporLanL concluslons of Lhls Lrend analysls are:
1. 1haL all of Lhe observed raLlos show a deLerloraLlng Lrend as bankrupLcy approaches, and
2. 1haL Lhe mosL serlous change ln Lhe ma[orlLy of Lhese raLlos occurred beLween Lhe Lhlrd and Lhe
second years prlor Lo bankrupLcy.
1hls proves LhaL Lhe z score model was model ls an accuraLe forecasLer of fallure up Lo Lwo years prlor Lo
dlsLress and LhaL accuracy dlmlnlshes subsLanLlally as Lhe lead Llme lncreases
1he welghLs Lo each of Lhe dlscrlmlnanLs are asslgned by flrsLly dlsLlngulshlng Lhem lnLo dlfferenL groups
uslng Lhe l-LesL meLhod and Lhen sLrengLhenlng Lhe facL LhaL each dlscrlmlnanL ls from a dlfferenL
populaLlon by re[ecLlng lLs null hypoLhesls. Cnce Lhe coefflclenLs are deLermlned Lhls has been rlgorously
LesLed and reLesLed on Lhe Lwo groups of Lhe samples and Lhe followlng zones were deLermlned:

2ones of D|scr|m|nat|on:
Z > 2.99 -Safe" Zone
1.8 < Z < 2.99 -Crey" Zone
Z < 1.80 -ulsLress" Zone

1he flnal values so arrlved upon from Lhe dlscrlmlnanL funcLlon can be classlfled lnLo one of Lhe followlng
groups from where Lhe probablllLy of Lhe flrm golng bankrupL can be deLermlned. 1hese classlflcaLlons
are emplrlcal ln naLure and Lhey have been arrlved aL, by LesLlng anoLher sample of 66 flrms whlch were
lncurrlng a neL loss (deflclL) beLween Lhe years of 1938 and 1961. 1hls LesL showed LhaL 32 ouL of Lhe 66
flrms selecLed were classlfled correcLly, 79 accuracy ln predlcLlng Lhe zones. AlLhough Lhese LesLs have
been conducLed on daLa from over 30 years ago, Lhey sLlll prove Lhelr robusLness as Lhey employ Lhe
fundamenLal facLors of any buslness Lo arrlve aL Lhe declslon maklng value.
':";#$(> #54 6780%-4 2%- ;-$3"#4 2$-9+
Slnce Lhe value of ln Lhe funcLlon ls Lhe flrm's markeL value of equlLy/book value of LoLal llablllLles and
Lo deLermlne Lhe markeL value of a prlvaLely held flrm would noL be accuraLe, Lhe model would need Lo
be re-esLlmaLed Lo lnclude Lhe book value of Lhe equlLy of Lhe prlvaLely held flrm. So Lhe revlsed model ls
as follows:
Z' = 0.717 + 0.847 + 3.107 + 0.420 + 0.998


Where, = 8ook value of eoulLy/ LoLal llablllLles
1he zones of dlscrlmlnaLlon for prlvaLe flrms wlll also change as follows:

2ones of D|scr|m|nat|on for pr|vate f|rms:
Z > 2.90 -Safe" Zone
1.23 < Z < 2.90 -Crey" Zone
Z < 1.23 -ulsLress" Zone





12

G8<73 %<393?5< %446</= 39 *37:378/6 16480;/=

lama (1986), Wllson (1997), Carey (1998), and AlLman and 8rady (2001) documenLed LhaL defaulL raLe
varles wlLh buslness cycle. 1he argumenL LhaL defaulL rlsk ls assoclaLed wlLh buslness cycle on recognlLlon
LhaL banklng lndusLry ls also cycllcal and bank Lends Lo LlghLen Lhe credlL or lendlng acLlvlLy durlng Lhe
economy down Lurn. Many oLher credlL defaulL predlcLlon models do noL lncorporaLe Lhe
macroeconomlc varlable because lL ls noL posslble Lo dlsLlngulsh beLween Lwo posslble explanaLlon l.e. 1)
ldenLlfy wheLher lncrease ln Lhe ex anLe rlsk of defaulL durlng recesslon and 2) lncrease ln ex posL
reallzaLlon of defaulL durlng recesslon.
CLher sLudles provlde evldence LhaL defaulLs are lndusLry speclflc lncldence. ln order Lo undersLand Lhe
lmpacL of macroeconomlc varlable and esLabllsh LhaL macro economlc maLLers ln defaulL predlcLlon
beyond flrm speclflc and Lhe lndusLry speclflc, xlanghong Ll
3
and xlnlel Zhao
4
worked ouL a duraLlon
model uslng a loglsLlc regresslon defaulL probablllLy. uuraLlon model analysls speclflc flrm's defaulL's rlsk
as an evoluLlonary process and each perlod, Lhe rlsk of Lhe defaulL ls a funcLlon of macroeconomlc
condlLlon, lndusLry condlLlon, flrm's condlLlon and flrm's age.
Durat|on Mode|:


\ (t) - ls deflned over 1 < t < M l
r - denoLes Lhe calendar Llme of Lhe sLarL of Lhe spell for flrm l .

x
$,#?# $7 1
- conLalns flrm characLerlsLlcs (lncludlng accounLlng and markeL varlables),
@(:
#?#$7A
- conLrols for Lhe lndusLry effecL, and
B
#+r| -1 -
are macroeconomlc varlables aL calendar Llme #+r| -1

All Lhe Llme varylng varlables on Lhe rlghL hand slde are lagged by one perlod because Lhe purpose of Lhe
model ls Lo predlcL fuLure defaulL.
f (log (t)) ls a polynomlal funcLlon of log (t), approxlmaLlng how Lhe hazard raLe depends on Lhe
solvency duraLlon.


C"0-% 40%(%9$0 2"0#%-+=

3
?8@')*78"* %A ;$%"%7+$6 B%)C ."+D8)6+*2 18"* E*'*8 ."+D8)6+*2F G%)%"*%F >'"'4'
4
?8@')*78"* %A H+"'"$8 >%&&858 %A 0I6+"866 J47+"+6*)'*+%"F 18"*F .:E:J
13

8elow are Lhe macroeconomlc facLors whlch have an lnherenL effecL on a flrm's performance:

Aggregate Market returns:
lL ls a valued by Lhe welghLed average reLurns of n?SL- AMLx- nASuAC and sLock prlces are Lhe leadlng
lndlcaLor of Lhe fuLure buslness acLlvlLy. So we can conclude LhaL markeL reLurns have negaLlve co-
relaLlon wlLh defaulL probablllLy

Cred|t spread:
CredlL spread here means Lhe dlfference ln Lhe yleld of 888 and AAA bonds and credlL spreads are Lhe
leadlng lndlcaLor of a buslness cycle. lL Lends Lo rlse (fall) durlng conLracLlon (expanslon). A poslLlve
relaLlon credlL spread and fuLure defaulL probablllLles may exlsL.

1erm Spread:
lor Lhe sake of Lhe model above, lL ls deflned as Lhe dlfference beLween Lhe yleld of a 10 yr 1-blll and a 3
monLh 1-blll. revlous research has shown LhaL Lerm spreads are good predlcLors of fuLure buslness cycle
and a hlgh Lerm spread porLends a sLrong economy ahead. 1herefore, Lerm spreads may be negaLlvely
relaLed Lo fuLure defaulL probablllLy.

kea| Interest rate:
8eal lnLeresL raLe ls Lhe dlfference beLween nomlnal lnLeresL raLe on 3 monLhs 1-bllls and lnLeresL raLe.
Plgher lnLeresL raLe leads Lo LlghLenlng money supply and funds for caplLal expendlLure and less
consLrucLlon. So Plgher lnLeresL raLe leads Lo lncrease ln borrowlng cosL and decllne ln buslness acLlvlLy.
So real lnLeresL raLe poslLlvely relaLed Lo probablllLy of defaulL raLe.

Inf|at|on:
no sLudy has provlded any concluslve evldence of relaLlon beLween lnflaLlon and Lhe defaulL probablllLy
raLe. 8uL here lL has been assumed LhaL lnflaLlon would have poslLlve relaLlon wlLh defaulL probablllLy, lf
aL all lnflaLlon has any lmpacL.

Unemp|oyment:
1he relaLlon beLween buslness cycle and unemploymenL has been documenLed slnce 1927
3
and lL has
been proved LhaL Lhe unemploymenL raLe negaLlvely lmpacLs buslness acLlvlLles. So lL ls expecLed LhaL
hlgh unemploymenL raLe has poslLlve relaLlon wlLh defaulL probablllLy.







3
MlLchell (1927) and keynes (1936)
14

G67/39N= G316; 437 M8;059L 8 <3?:892

ln Lhe paper wrlLLen by 8oberL C MerLon ln 1973, he explalns Lhe derlvaLlon of Lhe value of a company ln
relaLlon Lo Lhe value of Lhe debL lssues by Lhe company. Cne of Lhe precondlLlons Lo prlce a corporaLe
bond ls Lhe probablllLy of Lhe flrm Lo defaulL, whlch depends on Lhe value of Lhe equlLy of Lhe flrm.
1herefore ln Lhe model below we have analysed Lhe porLlon speaklng malnly regardlng Lhe aspecLs of
arrlvlng aL Lhe value of Lhe flrm on whlch furLher sLudles/models are based.
MerLon explalns LhaL Lhe value of any corporaLe debL depends on 3 facLors:
- 1he requlred raLe of reLurn Lhe flrm expecLs on rlsk free debL, l.e. govL Lreasury bonds/bllls
- 1he sLlpulaLed precondlLlons of Lhe debL lssued, l.e. Lhe coupon raLe, maLurlLy daLe, Lerms of call eLc.
- 1he probablllLy LhaL Lhe flrm wlll noL be able Lo pay lLs lndenLure provlsos, l.e. Lhe flrm's probablllLy of
defaulL.

1he sLudy MerLon focussed was malnly on prlclng bonds and corporaLe debLs when Lhe flrm shows a hlgh
probablllLy of defaulL Lherefore measurlng Lhe rlsk sLrucLure of Lhe flrm and Lhe lnLeresL raLes lL recelves.
1he emphaslses ls on relaLlng Lhe credlL rlsk Lhe flrm ls exposed Lo, Lo Lhe caplLal sLrucLure of Lhe flrm
1he 'rlsk' menLloned by Lhe model perLalns Lo Lhe posslblllLy of unanLlclpaLed galns or losses arlslng Lo
Lhe bondholders as a resulL of Lhe changes ln Lhe probablllLy of defaulL of Lhe flrm and noL Lhe
unanLlclpaLed galns or losses caused by a general change ln Lhe lnLeresL raLes (markeL/economy).
1he followlng assumpLlons have been made for consLrucLlng Lhe model. 1he model so has been modelled
on Lhe llnes of Lhe 8lack Scholes Lype of a prlclng model. 1he assumpLlons whlch are a parL of Lhe model
are as follows:
1here are no LransacLlon cosLs, Laxes and Lhe asseLs are freely dlsLrlbuLable.
1here ls a markeL whereln each lnvesLor ls able Lo geL Lhe prlce for any asseL as Lhey requlre/deslre.
l.e. Lhe number of lnvesLors ln any markeL and Lhelr comparable wealLh ls of a large base.
1he raLe of borrowlng and lendlng of funds can exlsL aL Lhe same raLes.
ShorL sales of all asseLs, wlLh full use of Lhe proceeds, ls allowed
1radlng ln asseLs Lakes place conLlnuously ln Llme. l.e. Lhe markeLs for Lradlng Lhese asseLs ls open
all Lhe Llme
1he Modlgllanl-Mlller Lheorem whlch sLaLes LhaL Lhe value of Lhe flrm ls lnvarlanL Lo Lhe caplLal
sLrucLure of Lhe flrm.
1he rlskless raLe of a rlskless dlscounL bond whlch promlses Lo pay one dollar aL a Llme 1 ln Lhe
fuLure ls (1) = exp[-r1
6
], ls consLanL for all Lhe Llme. 1hls assumpLlons ls made so as Lo clearly
dlsLlngulsh Lhe sLrucLure of rlsk from Lhe sLrucLure of Lhe Llme perlod whlch effecL Lhe prlclng of Lhe
bond
1he dynamlcs for Lhe value of Lhe flrm, v, Lhrough Llme can be descrlbed by a dlffuslon-Lype
sLochasLlc process wlLh sLochasLlc dlfferenLlal equaLlon whlch ls :

dv = (av - C) dL + / vdz

Where-
a: Lhe lnsLanLaneous expecLed raLe of reLurn on Lhe flrm for per unlL Llme
C: ls Lhe LoLal dollar payouLs by Lhe flrm Lo lLs shareholders or llablllLy holders l.e. dlvldend or lnLeresL
paymenLs.
: ls Lhe sLandard devlaLlon of Lhe reLurn on Lhe flrm per unlL of Llme.

6
lormula for conLlnuous compoundlng.
13

dz: ls a sLandard Causs- Wlener process

1hls LranslaLes Lo LhaL Lhe prlce movemenLs on securlLles are conLlnuous and LhaL Lhe unanLlclpaLed
reLurns are lndependenL whlch ls conslsLenL wlLh Lhe 'LfflclenL markeL hypoLhesls'

under Lhese assumpLlons, Lhe equlLy of Lhe flrm ls a call opLlon on Lhe underlylng value of Lhe flrm wlLh
a sLrlke prlce equal Lo Lhe face value of Lhe flrm's debL and a Llme-Lo-maLurlLy of 1. luncLlonally wrlLLen
as ?=f (v, L). ln modelllng Lhe formula accordlng Lo Lhe assumpLlons above we arrlve aL Lhe facLors Lhe
value of Lhe flr
m ls dependenL on. l, accordlng Lo MerLon's model depends on:
1he lnLeresL raLes
1he flrm's buslness rlsk ( volaLlllLy of Lhe flrm's value)
1he dlvldend payouL pollcy of Lhe flrm and Lhe facLors whlch do noL affecL Lhe value of Lhe flrm are:
1he expecLed raLe of reLurn on Lhe flrm
1he rlsk preferences of lLs lnvesLors

1hls ls, ln oLher words:
1he value of Lhe flrm's debL ls equal Lo Lhe value of a rlsk-free dlscounL bond mlnus Lhe value of a puL
opLlon wrlLLen on Lhe flrm, agaln wlLh a sLrlke prlce equal Lo Lhe face value of debL and a Llme-Lo-
maLurlLy of 1
1herefore lL concludes LhaL Lhe value of securlLy ls a funcLlon of Lhe polnL of Llme and Lhe value of Lhe
flrm. lL depends on Lhe lnLeresL raLe, Lhe volaLlllLy of Lhe flrm's value as measured by lLs varlance, Lhe
payouL pollcy of Lhe flrm Lo lLs shareholders and bondholders.
lL can be noLed LhaL all Lhe above parameLers and varlables excepL varlance can be observed dlrecLly and
Lhe varlance can be esLlmaLed from a Llme serles daLa.
16

OGPBG67/39 *7615/ G395/37 G316;

1he kMv-MerLon model ls a Lrademarked model of Lhe kMv Corp ln Lhe 1980's and Lhls ls used Lo
calculaLe Lhe defaulL frequency of publlcly Lraded companles. Slnce Lhe acqulslLlon of kMv corp ln 2002
by Moody's, lL has been renamed as Lhe Moody's kMv model.
'( "/+#-"0# %2 #54 9%:4)
1he probablllLy of defaulL ls calculaLed by subLracLlng Lhe face value of Lhe flrm's debL from an esLlmaLed
markeL value of Lhe flrm and Lhen dlvldlng Lhls value by Lhe esLlmaLed volaLlllLy (rlsk or sLandard
devlaLlon) borne by Lhe flrm. 1he markeL value ln Lhls case ls Lhe sum of Lhe markeL values of Lhe debL of
Lhe flrm and equlLy. A Z-score resulLs from Lhls calculaLlon. lrom Lhls value Lhe dlsLance Lo defaulL ls
deLermlned whlch ls Lhen applled ln a cumulaLlve denslLy funcLlon Lo arrlve aL Lhe defaulL probablllLy. lor
esLlmaLlng Lhe debL of Lhe flrm Lhe model uses Lhe MerLon (1974) model.
lL ls prlmarlly based on Lhe MerLon (1974) bond prlclng model
7
calculaLes Lhe expecLed uefaulL lrequency
(Lul) of a flrm, based on Lhe followlng lnherenL facLors of Lhe flrm:
- Va|ue of assets
- Asset r|sk
- Leverage
1he loglc LhaL ls used ln Lhe calculaLlng Lhe dlsLance Lo defaulL ln Lhe model ls based on Lhe assumpLlons
on Lhe dynamlcs of asseLs and Lhe sLrucLure of debL presenL ln Lhe flrm. 1herefore Lhe model ls
fundamenLally dlvlded Lo ascerLaln Lhe values of Lhe menLloned componenLs. A furLher explanaLlon of
each facLor ls explalned below ln deLall.
D")E4 %2 "++4#+
1he asseL value of Lhe flrm ls deLermlned by Lhe presenL value of Lhe fuLure cash flows Lhe flrm ls able Lo
generaLe. 1hls dlrecLly reflecLs Lhe asseL Lurnover capaclLy or Lhe asseL uLlllzaLlon ablllLy of Lhe flrm. 1hls
raLlo has also been hlghllghLed ln Lhe Z-score of AlLman (1968) as Lhe componenL of Lhe model. 1hls
shows Lhe dlrecL compeLency of Lhe managemenL Lo produce revenues lrrespecLlve of Lhe sLaLe of Lhe
economy. Cne has Lo keep ln mlnd LhaL Lhls capaclLy wlll vary from lndusLry Lo lndusLry.
'++4# !$+1
1hls measure Lakes lnLo conslderaLlon Lhe flrm's lnLernal and exLernal rlsks l.e. buslness and lndusLry
rlsks. 1he asseLs of any publlcly Lraded flrm are measure ln Lerms of lLs markeL values and noL on whaL
has been reflecLed ln Lhe books of Lhe flrm whlch ls neL of depreclaLlon. ln deLermlnlng Lhls value, we
have Lo Lake lnLo conslderaLlon Lhe varlous rlsks and uncerLalnLles LhaL wlll be lnvolved durlng valulng
Lhem. MosL of Lhese rlsks lnvolved cannoL be quanLlfled reallsLlcally and cannoL be dlrecLly observable,
some of whlch may lnclude consumer psychology, markeL Lrends eLc., because of whlch one arrlves aL an
esLlmaLe flgure aL valulng Lhe rlsks whlch are lnherenL ln Lhe asseLs of Lhe flrms. 1hls lnformaLlon ls Lhen
scaled Lo Lhe horlzon of Lhe forecasL so LhaL lL pro[ecLs a reallsLlc value of defaulL. 1hls ls done as Lhe rlsk
varlables are unlque Lo Lhe flrm aL every polnL of Llme and lL lncludes a reflecLlng of Lhe macroeconomlc
condlLlons Lhe flrm exlsLs ln.



7
As explalned ln Lhe MerLon's model ln Lhe prevlous chapLer
17

F434-">4
1hls measures Lhe composlLlon of Lhe caplLal or Lhe caplLal sLrucLure of Lhe flrm. 8orrowlng funds Lo
supplemenL Lhe caplLal sLrucLure magnlfles Lhe reLurn LhaL Lhe shareholders recelve and also acLs as a Lax
shleld for Lhe company. Whlle we can flnd Lhe relevanL measures of measurlng Lhe markeL value of asseLs
and equlLy, Lhere ls no deflned meLhod of ascerLalnlng Lhe markeL value of all Lhe flrm's debL (long and
shorL Lerm). 1herefore Lhe perLlnenL measure ls consldered as Lhe markeL value of Lhe flrm's asseLs Lo Lhe
book value of Lhe llablllLles slnce Lhls ls Lhe value LhaL Lhe flrm musL repay Lo lLs conLracLual obllgaLlons
1he kMv's defaulL predlcLor sLudy has found LhaL Lhe flrms ln general don'L defaulL when Lhe value of
Lhelr asseLs ls equal Lo Lhe book value of Lhe LoLal llablllLles. AL Lhls polnL mosL flrms are able Lo servlce
Lhelr conLracLual obllgaLlons by [usL performlng Lhelr day Lo day Lradlng/buslness acLlvlLles. Also, slnce
Lhe debL ls long Lerm ln naLure, lL provldes a cerLaln breaLhlng space for flrms ln Lerms of repaymenL rlsk.
1hls polnL ls lllusLraLed as below. Accordlng Lo Lhe kvM model, we assume Lhe flrm's caplLal Lo conslsL of
equlLy, long Lerm debL whlch ls assumed Lo be a perpeLulLy, shorL Lerm debL whlch ls equlvalenL Lo cash
and converLlble preference shares






G"0#%-+ $(2)E4(0$(> " 2$-9H+ :42"E)# ;-%/"/$)$#*
1he kvM model found LhaL Lhe value aL whlch Lhe flrm wlll generally defaulL ls somewhere ln beLween
Lhe LoLal llablllLles and Lhe shorL Lerm llablllLles. 1hls ls a slLuaLlon when Lhe LoLal asseLs of Lhe flrm are
less Lhan or equal Lo Lhe LoLal llablllLles and Lhls resulLs ln a condlLlon of Lhe flrm havlng a non poslLlve
neL WorLh. 1he menLloned condlLlon can also arlse ln Lhe case of a Lemporary mlsmaLch of asseLs and
llablllLles, whlch would noL ln reallLy resulL ln Lhe flrm defaulLlng.
So Lo arrlve aL Lhe relevanL neL WorLh of a flrm we have Lo Lake Lhe markeL value of lLs asseLs mlnus Lhe
defaulL polnL of Lhe flrm. 1hls value wlll be Lhe markeL neL worLh of Lhe flrm.
,42"E)# I%$(#
Accordlng Lo kMv, Lhe defaulL occurs when Lhe asseL value reaches a level somewhere beLween Lhe
value of LoLal llablllLles and Lhe value of shorL-Lerm debL. 1hls polnL ls named defaulL polnL (u1), and lL ls
consldered by kMv as Lhe shorL-Lerm debL plus half Lhe long-Lerm debL. 1hls has been lllusLraLed below.


18


u1- uefaulL polnL

1he d|stance-to-defau|t (DD) |s the number of standard dev|at|ons between the mean of the
d|str|but|on of the assets va|ue and the defau|t po|nt (D1).
,$+#"(04 #% ,42"E)#
A flrm ls sald Lo defaulL when lLs markeL neL worLh reaches zero. A flrm wlll defaulL when lLs markeL neL
worLh reaches zero. Llke Lhe flrm's asseL value, Lhe markeL measure of neL worLh musL be consldered ln
Lhe conLexL of Lhe flrm's buslness rlsk. lor example, flrms ln Lhe food and beverage lndusLrles can afford
hlgher levels of leverage (Lower markeL neL worLh) Lhan hlgh Lechnology buslnesses because Lhelr
buslnesses, and consequenLly Lhelr asseL values, are more sLable and less uncerLaln. 1he defaulL
probablllLy of Lwo flrms across Lwo dlfferenL lndusLrles wlll depend upon Lwo facLors, Lhe asseL volaLlllLy
(usually Lhe lndusLry parameLer) and Lhe dlsLrlbuLlon funcLlon and Lhe dlsLance Lo defaulL (usually Lhe
borrower speclflc facLor). 1he dlsLance Lo defaulL ls measured ln Lerms of asseL volaLlllLy. A flrm's
leverage has Lhe effecL of magnlfylng lLs underlylng asseL volaLlllLy. As a resulL, lndusLrles wlLh low asseL
volaLlllLy (for example, banklng) Lend Lo Lake on larger amounLs of leverage whlle lndusLrles wlLh hlgh
asseL volaLlllLy (for example, compuLer sofLware) Lend Lo Lake on less. As a consequence of Lhese
compensaLory dlfferences ln leverage, equlLy volaLlllLy ls far less dlfferenLlaLed by lndusLry and asseL slze
Lhan ls asseL volaLlllLy. AsseL value, buslness rlsk and leverage can be comblned lnLo a slngle measure of
defaulL rlsk whlch compares Lhe markeL neL worLh Lo Lhe slze of a one sLandard devlaLlon move ln Lhe
asseL value. We refer Lo Lhls raLlo as Lhe dlsLance-Lo-defaulL.

1he dlsLance-Lo-defaulL measure comblnes Lhree key credlL lssues: Lhe value of Lhe flrm's asseLs, lLs
buslness and lndusLry rlsk, and lLs leverage.


19


I|gure 1
8



1he dlsLance-Lo-defaulL (uu) ls Lhe number of sLandard devlaLlons beLween Lhe mean of Lhe dlsLrlbuLlon
of Lhe asseLs value and Lhe defaulL polnL (u1).

E (V1) = expected asset value in 1 year
DPT = (short-term debt) + 1/2 (long-term debt)
S= volatility of asset returns
J+#$9"#$%( %2 2$-9 3")E4 D "(: 3%)"#$)$#* %2 2$-9 3")E4
We use Lhe underlylng prlnclple ln solvlng for Lhe value of Lhe flrm l.e. Lhe value of Lhe flrm's equlLy ls a
call opLlon on Lhe underlylng asseLs of Lhe flrm


k: Leverage raLlo
c: Average coupon raLe of long Lerm debL
t: 8lsk free raLe
v: value of flrm


8
Source: hLLp://www.ronalddomlngues.com/lndex.php?lang=&s=rlsk&ld=36

20

1he above Lwo equaLlons need Lo be solved slmulLaneously Lo arrlve aL Lhe values of flrm and lLs volaLlllLy
JK;40#4: ,42"E)# G-4LE4(0*
1he normal dlsLrlbuLlon of Lhe asseL dlsLrlbuLlon ls Lhe LxpecLed uefaulL lrequency (Lul)
lL ls a measure of probablllLy LhaL a company wlll defaulL wlLhln a glven horlzon, Lyplcally one year. 1he
Lul value essenLlally represenLs Lhe defaulL lnformaLlon LhaL ls conLalned ln a company's sLock prlce
comblned wlLh lLs laLesL flnanclal sLaLemenLs.
'0#E") ,42"E)# G-4LE4(0*
Cnce, Lhe Lul ls calculaLed, a defaulL daLabase ls used Lo derlve an emplrlcal dlsLrlbuLlon relaLlng Lhe
dlsLance-Lo-defaulL Lo a defaulL probablllLy. We call Lhls as Lhe AcLual uefaulL lrequency (Aul). 1he Aul ls
calculaLed as Lhe proporLlon of defaulLlng flrms belonglng Lo Lhe same lndusLry whlch have Lhe same
dlsLance Lo defaulL

1he above process deLermlnes Lhe defaulL probablllLy of a flrm by comparlng lL wlLh a copyrlghL daLabase
whlch ls malnLalned by Moody's corp.

21

)/012 Q $?:8</ 34 G8<73 M8758>;6=

1here are many evldences showlng LhaL flrm's defaulL raLe varles wlLh buslness cycle, e.g. lama (1986),
Wllson (1997), Carey (1998), and AlLman and 8rady (2001)). 1hey argue on Lhe basls of Lhe facL LhaL
durlng Lhe economlc down Lurn credlL acLlvlLy Lend Lo LlghLened leadlng Lo more defaulL
ln order Lo undersLand Lhe affecL of Lhe Macro economlc varlables and Lhelr lmpacL on Lhe performance
of Lhe flrm and on lLs flnanclal flgures, analysls has been done on Lhe cerLaln seL of flrms.
1he seL of flrms has been ldenLlfled malnly from Lhe geography of Lhe unlLed SLaLes and have defaulLed
durlng Lhe perlods of 2000-2008. 1hese flrms are chosen conslderlng Lhe slze of Lhe asseLs and Lhe flrm
havlng largesL asseL base has been prlorlLlsed ln Lhe selecLlon over Lhe selecLed perlod
llnanclal daLa of such flrms was capLured over a perlod of forLy elghL monLhs Lo one slxLy monLhs Lo
analyse and undersLand Lhe lmpacL of Lhe macroeconomlc varlable whlle coverlng Lhe enLlre buslness
cycle for Lhe flrm. Accordlng Lo Lhe naLlonal 8ureau of Lconomlc 8esearch (n8L8)
9
ln Lhe precedlng flfLy
slx years (1943-2001), Average buslness cycle ls of 67 monLhs (from peak Lo peak). lL has a mlnlmum ls 18
monLhs and maxlmum number of 116 monLhs.
CerLaln macroeconomlc varlables were ldenLlfled afLer sLudylng varlous llLeraLure llke xlanghong Ll and
xlnlel Zhao ln 2006, lama (1986) and AlLman 8rady (2001), Shumway (2001), Chava and !arrow (2004),
8haraLh and Shumway (2003), PlllegelsL, keaLlng, uonald, and LundsLedL (2003), and SareLLo (2003)).
1hese lnclude lnLeresL raLe, lnflaLlon raLe and gross domesLlc producL. All Lhese varlables consLlLuLe Lhe
exLernal envlronmenL of Lhe flrm ln whlch lL operaLes. 1hese varlables prlmarlly affecL Lhe flnanclal
worklng of Lhe company ln Lhe long run. 1hls paper has consldered Lhe daLa seL over a number of years
conslderlng Lhe facL LhaL slngle perlod raLlo may noL Lhe Lrue reveal Lhe flnanclal healLh of Lhe company.
Macro Lconom|c var|ab|es:
@(2)"#$%(=
SLudles such as lama (1981), Ceske and 8oll (1983), 8am and Spencer (1983), and SLulz (1986) shows a
negaLlve relaLlon beLween real acLlvlLy and lnflaLlon, whlle oLher sLudles, such as Lee (1992), flnds LhaL
lnflaLlon explalns llLLle varlaLlon ln Lhe real acLlvlLy.
lnflaLlon ls Lhe measure LhaL examlnes Lhe prlces of Lhe baskeL of Lhe consumer goods and servlces such
as LransporLaLlon. Consumer prlce lndex ls calculaLed by measurlng Lhe changes ln Lhe prlce level of Lhe
baskeL of Lhe goods aL predeLermlned level over a perlod of one year. 1he goods are welghLed accordlng
Lo Lhelr lmporLance. Changes ln Consumer prlce lndex (Cl) are used Lo assess prlce changes assoclaLed
wlLh Lhe cosL of llvlng.
'Cl ls one of Lhe mosL frequenLly used sLaLlsLlcs for ldenLlfylng perlods of lnflaLlon or deflaLlon. 1hls
ls because large rlses ln Cl durlng a shorL perlod of Llme Lyplcally denoLe perlods of lnflaLlon and large
drops ln Cl durlng a shorL perlod of Llme usually mark perlods of deflaLlon'
10
.

9
n8L8 ls a research organlzaLlon dedlcaLed Lo sLudylng Lhe sclence and emplrlcs of economlcs.
(hLLp://www.nber.org/cycles.hLm)
10
Source: hLLp://www.lnvesLopedla.com/Lerms/c/consumerprlcelndex.asp
22

lor Lhls sLudy, average consumer prlce lndex raLe of Lhe CrganlsaLlon of Lconomlc Co-CperaLlon and
uevelopmenL (CLCD)
11
member counLrles ls consldered Lo evaluaLe Lhe movemenL of Lhe consumer prlce
lndex and Lhe flrm's flnanclal healLh. lL ls assumed LhaL CLCu Cl raLe would have more effecL on Lhe flrm
speclflc as Lhe companles ln our daLa seL are of mulLlnaLlonal operaLlons.
@(#4-4+# !"#4=
SLudles such as llorlLo and kolllnLzas (1994), show LhaL lnLeresL raLes are Lhe leadlng lndlcaLors of
buslness cycles ln u.S. Accordlng Lo Lhe arLlcle
12
publlshed by Lhe Amerlcan Lconomlc AssoclaLlon lnLeresL
raLe falls durlng Lhe recesslonary perlod.
lnLeresL raLe here ls deflned as percenLage amounL charged by Lhe lenders as a compensaLlon for Lhe loss
of asseL value. AsseL borrowed could lnclude cash, consumer goods. lnLeresL ls essenLlally a renL or
leaslng charge Lo Lhe borrower. lnLeresL raLes are flxed by Lhe cenLral bank of Lhe naLlons.
13

lor Lhe purpose of Lhls sLudy, long Lerm lnLeresL raLe ls used because of Lhe facL LhaL corporaLlons borrow
conslderable amounLs of long Lerm debL for Lhelr buslness operaLlon and Lhe lnLeresL amounL ls
slgnlflcanL lLem of Lhe expendlLure ln Lhelr proflL and loss accounL. Also ralslng loans ls consldered good
for Lhe flrm buL afLer a cerLaln level lL lncreases Lhe rlsk level of Lhe company as Lhe leverage lncreases.
Average of long Lerm lnLeresL raLe prevalllng ln CLCu naLlons ls used Lo evaluaLe Lhe movemenL of Lhe
long Lerm lnLeresL raLe and Lhe flrm's defaulL probablllLy.
M-%++ ,%94+#$0 I-%:E0# M-%.#5 !"#4=
Cu ls Lhe moneLary value of all Lhe flnlshed goods and servlces produced wlLhln a counLry's borders ln a
speclflc Llme perlod. Annual growLh ln Lhe Cu sald Lo Cu growLh raLe. lL ls commonly used as
an lndlcaLor of Lhe economlc healLh of a counLry.
ln Lhls sLudy, average Cu growLh raLe of Lhe CLCu naLlons are used Lo evaluaLe Lo growLh and flrms
defaulL probablllLy.
I|rm Spec|f|c Var|ab|es:

1here are cerLaln flrm speclflc raLlos, whlch slgnlflcanLly affecL Lhe flrm's flnanclal fuLure and also lndlcaLe
Lhe same. Ldward l. AlLman ln 1968, kMv MerLon (1980) ldenLlfled cerLaln flrm speclflc varlables such as
lnLeresL coverage raLlo, long Lerm debL Lo LoLal asseL and worklng caplLal Lo LoLal asseL raLlos are Lhe
mosL slgnlflcanL raLlos Lo deLermlne Lhe healLh of Lhe buslness flrm
@(#4-4+# 0%34-">4 !"#$%=

lL ls has been observed LhaL lf a flrm ls noL able Lo generaLe enough proflL Lo payback lLs lnLeresL
obllgaLlons lLs flnanclal poslLlon may be deLerloraLlng, whlch may lead Lhe company Lo a poslLlon of
defaulL or prone Lo defaulL aL some polnL of Llme. A company wlll noL be able Lo survlve lf lL ls ln Lhls
slLuaLlon for a number of flnanclal years consecuLlvely. lnLeresL coverage raLlo has been deflned as
number of Llmes Lhe company ls able Lo generaLe proflL over and above Lhe lnLeresL amounL lL ls
obllgaLed Lo pay Lo lLs credlLors. roflL before lnLeresL and Lax ls consldered Lo calculaLe Lhe above raLlo.

11
Organisation of Economic Co-Operation and Development (OECD) is an international organisation
having thirty countries has its member nations.
http://www.oecd.org/home/0,2987,en_2649_201185_1_1_1_1_1,00.html
12
1be Ametlcoo cooomlc kevlew, vol. 83
13
Source: hLLp://www.lnvesLopedla.com/Lerms/l/lnLeresLraLe.asp
23

@(#4-4+# 0%34-">4 -"#$% N@O!P= I-%2$# /42%-4 @(#4-4+# "(: #"KQ @(#4-4+# ;"*94(#

lf lC8 ls greaLer Lhan one, lndlcaLes LhaL flrm ls able Lo cover lLs lnLeresL llablllLy wlLh lLs proflLs afLer
deducLlng operaLlng expenses and lf lL ls less Lhan one, Lhe flrm may noL able Lo pay back lLs lnLeresL Lo lLs
credlLors.
1hls paper has consldered Lhe daLe seL over Lhe menLloned perlod of Llme conslderlng Lhe facL LhaL slngle
perlod raLlo may noL be Lo reveal Lhe flnanclal healLh of Lhe company. 1hls raLlo may be less Lhan one due
Lo some abnormal clrcumsLances ln any parLlcular perlod of Llme whlch may glve wrong lndlcaLlon. So Lhe
raLlo ls analysed and lnLerpreLed over a perlod of Llme
F%(> #4-9 :4/# -"#$%=

Accordlng Lo Lhe MerLon, Lhe caplLal sLrucLure of a flrm consLlLuLes of long Lerm debL whlch effecLs Lhe
flrm's flnanclal poslLlon. lL has been LhoughL ouL LhaL lf a long Lerm debL of Lhe company ls greaLer Lhan
lLs LoLal asseLs, l.e. company's LoLal debL ls noL backed by Lhe asseLs ln Lhe flrm, lLs chances of Lhe defaulL
lncreases. Long Lerm debL here means any llablllLy whlch ls payable afLer one year and LoLal asseLs here
mean Lhe sum of Lhe LoLal flxed asseLs and currenL asseLs subLracLlng currenL llablllLles from LhaL.

F%(> #4-9 :4/# -"#$% NF<,!P= F%(> #4-9 :4/# )$"/$)$#* Q <%#") "++4#+

lf Lhls raLlo ls greaLer Lhan one, lL ls assumed LhaL Lhe flrm ls prone Lo commlL a defaulL lf Lhe slLuaLlon
conLlnuous for number of flnanclal years. Long Lerm debL raLlo ls hlgh or greaLer Lhan one when buslness
ls noL able Lo pay ls llablllLles and does noL generaLe any asseL Lo back Lhe debL amounL.

R%-1$(> O";$#") #% #%#") "++4# -"#$%=
Accordlng Lo Ldward l. AlLman ln 1968, worklng caplLal ls Lhe ma[or deLermlnanL of Lhe company's
flnanclal sLrengLh. lL reflecLs Lhe llquldlLy poslLlon of Lhe company for smooLh runnlng of lLs dally
operaLlons. Crdlnarlly, a flrm experlenclng conslsLenL operaLlng losses wlll have shrlnklng currenL asseLs
ln relaLlon Lo LoLal asseLs.
Worklng caplLal here means avallablllLy of Lhe llquld funds wlLh Lhe company ln Lerms of shorL Lerm
asseLs, cash, lnvesLmenLs, recelvables and any oLher asseL whose beneflL ls derlved for less Lhan a year
less Lhe currenL llablllLy such as accounLs payable and oLher llablllLy whlch are due or payable ln nexL one
year.
R%-1$(> 0";$#") #% #%#") "++4# -"#$%= OE--4(# '++4# )4++ 0E--4(# )$"/$)$#* Q <%#") "++4#+
lL has been consldered LhaL flrm should have an average lndusLry worklng caplLal wlLh lL Lo have smooLh
buslness operaLlons. lf Lhe flrm has conLlnuously lower worklng caplLal raLlo for number of years, lL may
lose opporLunlLy and lL may flnd dlfflculLy Lo survlve for a longer perlod of Llme.
G6/C313;3L2A
1he analysls has followed a loglsLlc regresslon approach Lo predlcL Lhe defaulL probablllLy of Lhe flrm over
a consecuLlve number of flnanclal years. llrms defaulL probablllLy ls sLudled ln comparlson Lo Lhe
movemenL ln Lhe Macroeconomlc varlable such as lnflaLlon raLe, lnLeresL raLe, and Cu growLh raLe. Such
macro economlc varlables are Lhe lndependenL varlables and Lhe flrm's flnanclal raLlos are Lhe dependenL
varlable and Lhese are affecLed by Lhe movemenL ln Lhe economlc varlable movemenL.
24

8lnary probablllLy of defaulL ls calculaLed on Lhe condlLlon LhaL lf Lhe flrm's long Lerm debL ls greaL Lhan
lLs LoLal asseL base, Lhen lLs operaLlng proflLs are less Lhan Lhe amounL of Lhe lnLeresL Lhe flrm needs Lo
pay Lo lLs credlLors and lLs worklng caplLal percenLage ls less Lhan Lhe average of Lhe lndusLry, Lhe flrm
flnanclal poslLlon ls consldered rlsky and lf slmllar slLuaLlon conLlnuous for a number of years, lL may lead
Lo defaulL.
8lnary defaulL probablllLy ls Lhan forecasLed Lhrough loglL regresslon model Lo geL Lhe defaulL probablllLy.
1he movemenL of such defaulL probablllLy would Lhen be sLudled wlLh macro economlc varlables such as
lnflaLlon raLe, lnLeresL raLe, and Cu growLh raLe by uslng Lhe earson's correlaLlon meLhod. lL helps ln
reflecLlng Lhe movemenL of Lhe defaulL probablllLy ln relaLlon Lo Lhe lndependenL varlable
Interpretat|on:
lL ls observed LhaL lnflaLlon raLe and lnLeresL raLe have lmpacL on Lhe defaulL probablllLy of Lhe flrm
whereas Cu growLh doesn'L show any speclflc resulL wlLh defaulL predlcLlon.
1hls sLudy conslders Lhree macro varlables and Lhree flrm speclflc raLlos Lo derlve Lhe relaLlonshlp among
Lhem.


lL ls observed ln J--%-S !424-4(04 +%E-04 (%# 2%E(:T LhaL a flrm's defaulL probablllLy has an lnverse
relaLlonshlp wlLh Lhe lnflaLlon raLe as well as Lhe lnLeresL raLe. lL means LhaL lf Lhe lnflaLlon raLe ls
decreaslng or economy has a deflaLlon slLuaLlon, flrm's chances of defaulL lncreases and lf Lhe lnflaLlon
raLe ls hlgh, flrm's defaulL probablllLy decreases. 1hls ls malnly due Lo Lhe facL LhaL lf Lhe lnflaLlon raLe ls
lncreaslng, Lhe flrms absoluLe proflL lncreases wlLh every unlL sale and lLs flnanclal poslLlon geL lmprove
on Lhe conLrary lf Lhe deflaLlon ls Lhere, Lhe prlces goes down and Lhe flrm proflLablllLy decreases,
weakened Lhe flnanclal poslLlon. lnflaLlon goes down generally ln Llme of recesslon.
lL ls also observed LhaL flrm's defaulL probablllLy has negaLlve relaLlon wlLh lnLeresL raLe. lL means lf Lhe
lnLeresL raLe falls, Lhe chances of Lhe defaulL of Lhe flrm's lncreases whereas lf Lhe lnLeresL raLe ln Lhe
economy lncreases, Lhe defaulL chances decreases.
23

Also Lhere ls poslLlve relaLlon beLween lnflaLlon raLe and lnLeresL raLe, as boLh Lend go ln Lhe same
dlrecLlon. lf Lhe lnflaLlon lncreases Lhe lnLeresL raLe also lncreases and lf lL decreases, lnLeresL raLe also
decreases.
ln Lhe glven seL of Lhe daLa, flrm's defaulL probablllLy shows an lnverse relaLlon wlLh lnLeresL raLe and
lnflaLlon raLe excepL u5 Altwoys. Cn close observaLlon lL ls found ouL LhaL ln Lhe flnanclal year 1999, Lhere
was a resLrucLurlng happened ln Lhe company ouL of whlch company's long Lerm debL raLlo has changed
and oLher flnanclal slLuaLlon also varles.


I|gure 2
14

WlLh glven seL of Lhe daLa, lL ls emplrlcally found LhaL lnLeresL raLe and lnflaLlon raLe boLh have negaLlve
correlaLlon wlLh Lhe flrm's defaulL probablllLy. Crdlnarlly, lnflaLlon raLe and lnLeresL raLe decllne durlng
recesslon perlod. When Lhe economles sLarL decllnlng, Lhe demand for Lhe goods also falls ln comparlson
Lo Lhe supply brlnglng down Lhe consumer prlce lndex. 1he aggregaLe excess supply makes buslness
vulnerable Lo defaulL.
ln order Lo boosL demand, cenLral banks brlng down Lhe lnLeresL raLe level and lnfuse llquldlLy. 1here ls a
poslLlve relaLlon among Lhe movemenL of Lhe lnLeresL raLe, lnflaLlon raLe and Cu growLh raLe (llgure 1).
Above such varlables have an lnverse relaLlonshlp wlLh flrm's defaulL probablllLy
1herefore, durlng recesslon Lhe defaulL probablllLy of Lhe flrm lncreases.
L|m|tat|ons
SLudy ls based on Lhe flnanclal lnformaLlon of seL of Lwelve flrms represenLlng secLors conslsLlng
of manufacLurlng, alrllnes and servlce lndusLry of Lhe unlLed SLaLes. lL does noL represenL Lhe all
Lhe secLors such as banks, shlpplng eLc from any oLher economles. 1he flnanclal lnformaLlon for
48 monLhs Lo 160 monLhs ls sLudled dependlng upon Lhe avallablllLy of Lhe lnformaLlon.
Average CLCu lnLeresL raLe, lnflaLlon raLe and Cu growLh raLe are consldered Lo undersLand
Lhelr lmpacL assumlng LhaL ln Lhe globallsed world, companles are operaLlng ln dlfferenL
geographles and CLCu naLlons can falrly be assumed as Lhe represenLaLlve of Lhe mosL of Lhe
buslness cenLres. lL ls qulLe unfeaslble Lo flnd ouL Lhe operaLlng reglons of Lhe flrms ln Lhe daLa
seL.

14
Source: CLCD fact book 2009
26

uebL raLlo may be hlgher ln cerLaln lndusLry even Lhan lL may noL be LhreaL Lo Lhe survlval of Lhe
company. ln Lhls paper Lhose companles are noL segregaLed separaLely because Lhe aLLempL here
ls Lo flnd ouL Lhe correlaLlon.
lL ls noL posslble Lo dlsLlngulsh beLween wheLher Lhe company defaulLs ln recesslon or posL
recesslon because of Lhe changes ln Lhe economlc envlronmenL durlng recesslon.
!::;5<8/539 34 /C6 !;/?89 RB)<376 G316;

1he AlLman Z Score model has been applled ln Lhls sLudy Lo deLermlne how flnanclal soundness of
selecLed exlsLlng companles ln Lhe SouLh LasL Aslan markeLs. 1hls sLudy has been conducLed Lo esLabllsh
where Lhese companles sLand ln Lhe currenL global scenarlo and commenL on lLs flnanclal poslLlon.
C4#5%:%)%>*
1he followlng companles have been consldered:

1ab|e 2
App||cat|on of 2 score mode|
Company neadquartered |n Sector
Alr Chlna Chlna Alrllnes
Chlna Cverseas Land Chlna 8eal LsLaLe developers
CaLhay Alr Pk Chlna Alrllnes
1oyoLa !apan AuLomoblle ManufacLurer
MlLsul ludosan Co LLd !apan 8eal LsLaLe developers
Alr Asla Malaysla 8udgeL Alrllnes
8er[aya Land Malaysla 8eal LsLaLe developers
Slngapore Alrllnes Slngapore Alrllnes
CaplLaLand Slngapore 8eal LsLaLe developers
SC Clobal Slngapore 8eal LsLaLe developers
CharLed
SemlconducLors Slngapore SemlconducLor manufacLurers
1SMC 1alwan SemlconducLor manufacLurers
Lmaar Croup
unlLed Arab
LmerlLus 8eal LsLaLe developers

1he raLlos accordlng Lo Lhe Z-Score model have been calculaLed for Lhe above companles. 1hese raLlos
are:
1. Worklng CaplLal/1oLal AsseLs (WC/1A).
2. 8eLalned Larnlngs/1oLal AsseLs (8L/1A)
3. Larnlngs before lnLeresL and 1axes/1oLal AsseLs (L8l1/1A)
4. MarkeL value of LqulLy/8ook value of 1oLal LlablllLles (MvL/1L)
3. Sales/1oLal AsseLs (S/1A)
27

1he deLalls of Lhese raLlos have been explalned ln Lhe model earller.
1he resulLs have been classlfled flrsLly reglon wlse and Lhen lndusLry wlse.
Country w|se reg|ona| c|ass|f|cat|on
AfLer havlng observed Lhe role of macroeconomlc facLors on Lhe lndusLrles of an enLlre reglon, Lhls
classlflcaLlon has been made Lo observe Lhls same Lrend ln Lhe SL Aslan reglon durlng Lhe perlods of
1999-2008. Aslan economles have a unlque feaLure of conslsLlng of counLrles whlch have developed and
developlng economles. uurlng Lhe recesslon, Lhls was Lrlggered by Lhe collapse of Lhe banklng sysLem ln
Lhe unlLed SLaLes, no counLry whlch has a free markeL has been able Lo shleld lLs lndusLrles from Lhe
global downLurn. 1herefore we have observed how Lhe recesslon has lmpacLed Lhe selecLed companles
durlng Lhls perlod. 8elow ls a graphlcal represenLaLlon of Lhe same for Lhe 6 Aslan naLlons.
lor Lhe sampled companles, Lhe AlLman's dlscrlmlnanL funcLlon has been used and Lhe Z Scores are
mapped ouL for each company agalnsL lLs respecLlve year.
WlLh a brlef over vlew of Lhe below charLs, we can clearly see LhaL profound effecLs of Lhe recesslon on
every counLry LhaL has been sampled. 1here ls a marked decllne ln Lhe sLablllLy of every company
observed durlng from Lowards Lhe end of 2006 Llll 2008. 1hls reflecLs Lhe obvlous effecLs of recesslon. A
furLher look aL Lhe values LhaL are dlrecLly affecLlng Lhe flnanclal sLablllLy of Lhe companles reveals LhaL
mosL of Lhe companles have had a huge llquldlLy crunch as Lhelr worklng caplLal has been ln Lhe negaLlve
for Lhe years durlng Lhe dlsLress.


*C598

I|gure 3
28

)59L8:376

I|gure 4


G8;82=58

I|gure S


-8:89
29


I|gure 6
30

.58K89


I|gure 7


S95/61 !78> %?675/0=


I|gure 8



31

Industry W|se C|ass|f|cat|on

1o examlne Lhe lndusLry speclflc causes for Lhe sample companles Lo be ln a dlsLressed sLaLe we shall
observe each company wlLhln lLs lndusLry across Lhe reglons. As explalned by Lhe AlLman model, Lhere
are cuL off polnLs Lo measure Lhe level of dlsLress of a company. We have modlfled Lhls benchmark score
for some lndusLrles based on varlous facLors slnce Lhe scope of Lhe model has noL been LesLed durlng a
perlod of wldespread recesslon such as Lhls. 1hese facLors have been explalned below along wlLh Lhe
lndusLry graph.
Slnce all Lhe companles exhlblL slgns of dlsLress, we cannoL assume LhaL Lhls ls an lndlcaLlon of
bankrupLcy LhaL Lhe companles may face ln Lhe fuLure. 1hls sLudy only focuses on Lhe relaLlve sLrengLh of
companles who are faclng Lhe same or slmllar macroeconomlc condlLlons. Also we have Lo bear ln mlnd
whlle lnLerpreLlng Lhese resulLs LhaL Lhey should noL be done so ln lsolaLlon. 1herefore we have coupled
Lhls research wlLh Lhe generlc Lrend of Lhe Z-Score of Lhese companles over a perlod of 3 Lo 8 years whlle
comparlng lL wlLhln lLs headquarLered counLry.
1he red llne ln every charL lndlcaLes Lhe polnL of safeLy whlch shall be deflned furLher as speclflc Lo Lhe
lndusLry


!57;596 5910=/72

I|gure 9

1he polnL of safeLy for Lhe alrllne lndusLry has been consldered as lL has deflned by Lhe dlscrlmlnanL
funcLlon l.e. 1.8 whlch ls Lhe grey area ln Lhls dlsLress lndlcaLor. 1he maln reason for a low score of Alr
Chlna as compared Lo Lhe oLher players ln Lhe lndusLry ls LhaL lL has been conslsLenLly ln a porLlon of
negaLlve worklng caplLal l.e. lL has conslsLenLly been faclng a llquldlLy crunch. CaLhay has only ln 2008,
succumbed Lo Lhe llquldlLy crunch Loo and has a negaLlve worklng caplLal as well.



32

(68; %=/8/6 &6M6;3:?69/

I|gure 10

1he same cuL off polnL of 1.8 has been used for Lhe real esLaLe developers as well. All Lhese companles
have been affecLed by drop ln Lhelr earnlngs and consequenLly a drop ln Lhe reLalned earnlngs as well.
CCLl has been able Lo beaL Lhe benchmark due Lo lLs large markeL value of lLs equlLy on Lhe conLrary
Lmaar has seen a large drop ln lLs markeL value. 1hls ls a consequence of large forelgn players who have
exlLed Lhe gulf markeL due Lo Lhe slump ln Lhe oll prlces and subsequenL slump ln Lhe properLy value ln
Lhe Mlddle LasL



@01L6/ !57;596=

I|gure 11
33

1he cuL off polnL ln Lhe case of budgeL carrlers has been Laken as an average of Lhe Lhree uS budgeL
companles whlch flled for bankrupLcy under Lhe chapLer 11 durlng Lhe years of 2004-2006. 1he
companles are Lhe same agalnsL whlch Lhe comparlson for Alr Asla has been made. 1he Lhree companles
have subsequenLly recovered from Lhelr bankrupLcy and are operaLlng wlLh Lhelr full sLrengLh. Agaln Lhe
causes for Alr Asla's dlsLress can be aLLrlbuLed Lo low earnlngs and lower reLalned earnlngs and reducLlon
ln lLs share value.


)6?5<3910</37 ?89048</0767=

I|gure 12
1he cuL off for Lhls lndusLry ls malnLalned as Lhe score of All Amerlcan SemlconducLors ln Lhe year lL flled
for lLs bankrupLcy l.e.2007. 1SMC have managed Lo malnLaln excepLlonal levels of sLablllLy desplLe Lhe
perlods of recesslon malnly due Lo Lhe facL LhaL lL has managed Lo remaln as Lhe world leader ln Lhe
manufacLurlng and supply of semlconducLors. Cn Lhe oLher hand CharLered have noL been able Lo
malnLaln Lhelr proflLs and posLed large losses ln 2008. 1hls cause a large llquldlLy crunch for CharLered
and Lhey subsequenLly wenL ln for a rlghLs lssue ln early March 2009
34

!0/3?3>5;6 G89048</0767

I|gure 13
1he cuL off ln Lhe case of 1oyoLa has been arrlved aL by Laklng Lhe average of Lhe Z-Scores for large
auLomoLlve parLs and manufacLurers LhaL flled for bankrupLcy under chapLer 11 durlng 2004-2006. 1hese
companles are 1rlco marlne, uura AuLomoLlves and 8emy lnLl Croup. 1oyoLa clearly shows reslllence
agalnsL Lhe recesslon as lLs score ls well above Lhe safe make.
keservat|ons of the Mode|
1. 1he Z-Score model uses hlsLorlcally daLa l.e. daLa from Lhe balance sheeL of Lhe flrm. SomeLlmes
Lhe exLernal envlronmenLal may force a flrm Lo declare bankrupLcy. Lhese could lnclude Lhe
pollLlcal envlronmenL of Lhe counLry Lhe flrm operaLes ln, Lhe naLural resources LhaL lL may use as
a prlmarlly and anclllary resource ln manufacLurlng, Lechnologlcal advancemenLs Lhe lndusLry
may adopL, legal lssues and mosL lmporLanLly and changes ln demand lL may have Lo face due Lo
Lhe rapld changes ln Lhe medlum of markeLlng and demographlcs LhaL ls seen world over Loday
2. 1he Z-Score compleLely lgnores Lhe fuLure flnanclal obllgaLlons LhaL are noL presenL ln lLs flnanclal
sLaLemenLs. ln Lhe llghL of Lhe recenL flnanclal crlses, off balance sheeL lLems have played a
slgnlflcanL role ln many of Lhe flnanclal lnsLlLuLlons declarlng bankrupLcy. 1here ls no effecL of
Lhese Lype of arrangemenLs LhaL a flrm geLs lnLo on Lhe raLlos LhaL are consldered for Lhe
calculaLlon of Lhls score
3. 1he Z-Score conslders only Lhe hlsLorlcal quanLlLaLlve aspecLs of Lhe flrms operaLlons. 1here are
varlous oLher lnLernal aspecLs LhaL need Lo be consldered before declarlng a flrm bankrupL. 1hese
lnclude any fuLure plans LhaL a company mlghL be plannlng Lo adopL or any expanslons LhaL lL
mlghL have planned. 1hls ls speclally Lrue for a new concern slnce lL would noL show very sLrong
flnanclals durlng lLs gesLaLlon perlods and would be aL rlsk of havlng hlgh debL equlLy raLlos. Cne
needs Lo keep ln mlnd Lhese quallLaLlve facLors before comlng Lo a concluslon on Lhe slLuaLlon of
a flrm declarlng bankrupLcy

33

$9/67:76/8/539
1hese flndlngs from Z -Score need Lo be lnLerpreLed ln Lhe llghL of Lhe recenL global recesslon Lo galn
more clarlLy on Lhe slLuaLlon of companles. Slnce Lhe credlL cycle has LlghLened, mosL companles wlLh
global operaLlons wlll suffer Llll Lhls perlod eases up. 1lll Lhls perlod we can make a [udgemenL from
polnLs ln Lhe pasL when companles from slmllar lndusLrles faced a slLuaLlon of bankrupLcy, wherever Lhls
daLa may be avallable.
1he explanaLlons of Lhe models used and oLher relevanL models ln predlcLlng defaulLs have been
explalned as below
36

,44B>8;89<6 )C66/ .789=8</539=

,42$($#$%(
1hese are LransacLlons ln buslnesses whlch are noL ln reflecLed ln Lhe balance sheeL of Lhe flrm. Such as
lease agreemenL, speclal purpose enLlLles, derlvaLlve conLracLs such as fuLures, forwards, opLlon, swaps
lnsLrumenLs and conLlngenL llablllLles such as leLLer of credlL, long Lerm commlLmenLs, corporaLe
guaranLees eLc can be caLegorlzed as off balance sheeL lLems.
lnlLlally Lhe purvlew of Lhe dlsclosure norms of Lhe off balance
sheeL lLems were llmlLed Lo Lhose whlch came under Lhe caLegory of Lhe relaLed parLy LransacLlons
deflned ln Lhe respecLlve laws. 8uL afLer Lhe debacle of Lhe Lnron case, Lhls sub[ecL maLLer has Laken
prlme lmporLance and Lhe SecurlLles Lxchange commlsslon has come wlLh dlsclosure norm of l861
(2002) and l8 67 (2003)
Some companles by lLs very naLure of operaLlons have slgnlflcanL lLems of off balance lLems ln Lhelr
balance sheeL. An explanaLory noLe of Lhe lmpacL of off balance sheeL lLems has been dlscussed below:
A|r||nes compan|es:
AfLer labour, [eL fuel ls Lhe second largesL operaLlng expenses of Lhe alr llnes companles. And [eL fuel
prlces are very flucLuaLlng. 1helr forecasLs and esLlmaLes hlghly depend on Lhe predlcLlon and conLrol of
Lhe [eL fuel prlces.
1he alrllne lndusLry, belng a very compeLlLlve lndusLry, lL ls dlfflculL Lo Lransfer Lhe cosL onLo Lhe
passenger.
Alrllnes companles Lend Lo hedge fuel prlces for Lhelr LlckeL cosLlng. So ma[orlLy alrllnes use plaln vanllla
derlvaLlve lnsLrumenLs. As [eL fuel ls derlved from oLher fuels and also slnce Lhere ls noL much llquldlLy ln
Lhe markeL for Lhe [eL fuel hedglng lnsLrumenL, Lhe alrllne companles enLer lnLo Lhe hedglng lnsLrumenL
for Lhe fuels on an lmplled assumpLlon of Lhe exlsLlng correlaLlon among Lhe varlous lnsLrumenLs. 8uL lf
due Lo an unforeseen happenlng, lf Lhese correlaLlons do noL hold good, Lhe lnsLlLuLlon wlll have Lo face a
blg Lrouble ln Lerms of Lhe rlsk exposure e.g. for a shorL perlod of Llme lf Lhere ls an lncrease ln [eL fuel
prlce hlgher Lhan Lhe crude cosL for Lemporary shorLage eLc. and crude cosL does noL lncrease Loo much,
Lhan alrllne company may have hlgh exposure Lo rlsk. llrms may noL make a proflL on derlvaLlve accounL
and buL would have Lo face loss on buylng a [eL fuel.
ln oLher slLuaLlons where derlvaLlve conLracLs ln [eL fuel lnsLrumenLs and [eL fuel prlce fall sLeeply, ln LhaL
case flrm's long poslLlon would lead Lhem Lo have hlgh balance sheeL rlsk exposure.
Account|ng for Der|vat|ve |nstrument:
1he flnanclal accounLlng sLandards board (lAS8) has lssued a sLaLemenL 133 (SlAS 133) Lo make Lhe
company's exposure of derlvaLlves LransparenL. lL sLaLes LhaL company has Lo record Lhe falr value of Lhe
derlvaLlve conLracLs' elLher ln lncome sLaLemenL or componenL of equlLy known as oLher comprehenslve
lncome.
37

1hls Lable summarlzes Lhe balance sheeL and lncome sLaLemenL lmpacLs of hedglng accordlng Lo SlAS
133.

1ab|e 3
1ype of Der|vat|ve 8a|ance Sheet Impact Income Statement Impact

Cash llow Pedge uerlvaLlve (asseL or llablllLy) ls
reporLed aL falr value. Changes ln
falr value of derlvaLlve are
reporLed as componenLs of
CLher comprehenslve lncome
(balance sheeL)

no lmmedlaLe lncome sLaLemenL
lmpacL. Changes ln falr value of
derlvaLlves are reclasslfled lnLo
Lhe lncome sLaLemenL (from
CLher Comprehenslve lncome ln
Lhe balance sheeL) when Lhe
expecLed (hedged) LransacLlon
affecLs Lhe neL lncome.
uerlvaLlve musL quallfy for
hedge accounLlng LreaLmenL.
lalr value Pedge uerlvaLlve (asseL or llablllLy) ls
reporLed aL falr value. Pedged
lLem ls also reporLed aL falr
value.

Changes ln falr value are
reporLed as lncome/loss ln Lhe
lncome sLaLemenL.
CffseLLlng changes ln falr value
of Lhe hedged lLem are also
reporLed as an lncome/loss ln
Lhe lncome sLaLemenL
SpeculaLlve 1ransacLlon uerlvaLlve (asseL or llablllLy) ls
reporLed aL falr value

Changes ln Lhe falr value are
reporLed as lncome/loss ln Lhe
lncome sLaLemenL.

@9;"0# %2 %22 /")"(04 +544# $#49+ %( #54 :42"E)# -"#4 %2 #54 2$-9

1hls ls a very lmporLanL facLor whlch needs Lo be consldered whlle calculaLlng Lhe defaulL raLes of a flrm
wlLh of vlew of Lhe recenL global economlc crlses whlch been propelled by non performlng asseLs and off
balance sheeL llablllLles whlch were noL hedged or covered adequaLely. 1he kvM model allows for Lhe
lncluslon of Lhese lLems under Lhe LoLal llablllLles and Lherefore effecLlvely lncreases Lhe defaulL polnL Lo
a LoLal value of llablllLles and off balance sheeL lLems. 1hls would ln Lurn lower Lhe asseL volaLlllLy as Lhe
leverage lncreases Lhe probablllLy of dlsLance Lo defaulL and Lhe Lul of Lhe flrm.
Spec|a| urpose ent|ty
AnoLher Lype of an arrangemenL whlch ls noL reflecLed ln Lhe balance sheeL of Lhe company ls Lhe
LransacLlon of Lhe enLlLles whlch are formed for some speclal purpose and has no dlrecL relaLlon wlLh Lhe
company. rlor Lo Lhe Lnron debacle, Lhe SecurlLles Lxchange Commlsslon (SLC) ln unlLed SLaLes requlred
Lhe dlsclosure of Lhe LransacLlon wlLh Lhose of Lhe relaLed parLles and LhaL relaLed parLy ls deflned ln Lhe
respecLlve laws of Lhe counLrles.

1hese enLlLles are formed generally ln Lhe form of [olnL venLure, LlmlLed LlablllLy CorporaLlon, parLnershlp
and anoLher unsollclLed enLlLy. 1hese are formed for some speclflc purpose, ofLen known as llmlLed
purpose enLlLy vehlcle. 1here scope of domaln ls also llmlLed malnly focuslng Lo Lhe broader ob[ecLlve of
Lhe maln corporaLlon such as Lransfer of Lhe company's asseLs or access Lo Lhe exLernal enLlLles. 1here
are many buslness reasons of creaLlng Lhe SLs such as lncreaslng flnanclal flexlblllLy ln Lerms of ralslng
38

funds Lhrough Lhe means of debL or equlLy, lnLer corporaLe loans LransacLlons as an when requlre. lL
decreases cosL of borrowlng by ralslng funds from Lhe enLlLy, whlch en[oys beLLer credlL raLlng. lL also
lmproves flnanclal raLlos by ralslng Lhe equlLy / debL ln dlfferenL organlsaLlons or purchaslng of Lhe
asseLs. lLs helps ln lmprovlng Lhe flnanclal raLlos of Lhe company such reLurn on equlLy, debL equlLy raLlo,
Lurn over raLlos eLc.

lf such speclal purpose enLlLles are creaLed for some leglLlmaLe purpose lL helps Lhe organlsaLlon Lo
lmprove lLs markeL poslLlon and proflLablllLy buL can also be used Lo mlslead Lhe sLakeholders. 8eferrlng
Lo Lhe case of Lnron debacle, Lhese enLlLles were creaLed Lo mlslead Lhe sLakeholders, hlde losses and
park Lhe cash. Lnron had more Lhan 3000 SLs and subsldlarles aL Lhe end of Lhe year 2000. MosL of
Lhem were creaLed ln neLherlands and Cayman lsland. 1hese were Lwo LradlLlonal Lax haven sLaLes. SLs
were creaLed ln Lhe form of llmlLed parLnershlp, llmlLed llablllLy companles, parLnershlps, and buslness
LrusL. Lnron flrsL SLs LransacLlon was named as CacLus". lL lnvolved ln Lhe creaLlon of Lhe SL for Lhe
purchase of Lhe one bllllon ln gas paymenL due Lnron from Lhe producers uLlllzlng Lnron's gas bank. And
sLake was sold Lo general LlecLrlc Company Co and oLher lnvesLors ln CacLus. 1hese lnvesLors sold back
Lhe gas Lon bank Lo Lnron, whlch Lhan sold lL lnLo Lhe markeL. 1hls LransacLlon was noL Lhe unusual one
buL Lhe reLurn Lo Lhe Lnron ralsed Lhe quesLlon wheLher Lhe sale Lo CacLus was Lhe orlglnal sale or noL.
no regulaLor even ralsed any ob[ecLlon on Lhls LransacLlon when lL was reporLed Lo publlc buL by Lhls
Lnron Lrled Lo mlslead lL sLake holders by showlng Lhe hlgh proflL ln Lhe balance sheeL of Lhe Lnron and
losses ln Lhe balance sheeL of Lhe CacLus.
Lease Agreement:
Lease agreemenLs are Lhe source of flnance Lo Lhe flrms. llrms can pracLlcally conLrol Lhe operaLlng
asseLs wlLhouL lnvesLlng ln such asseL upfronL. Lease agreemenLs
13
are classlfled ln operaLlng and caplLal
lease. CaplLal lease are slmllar as of buylng of Lhe asseL and wlll be shown ln Lhe 8alance sheeL of Lhe
lessee and Lease agreemenL whlch ls operaLlng ln naLure are noL recorded ln Lhe balance sheeL of Lhe
lessee and sald Lo be off balance sheeL lLem. ln such Lype of Lhe LransacLlons, sponsor lease ouL asseLs Lo
Lhe lessee ln Lurn of Lhe lease renLal. Lessee Lake Lhe advanLage of Lhe Lax deducLable lease renLal and lLs
balance sheeL wlll noL be affecL wlLh slze of Lhe asseL and equlLy/debL. 1hls wlll lmprove Lhe reLurn on
equlLy of Lhe company and lessor wlll show Lhe asseL ln lLs balance sheeL and deducL Lhe depreclaLlon ln
lLs accounL. CperaLlng lease are Lhe one of Lhe largesL source of Lhe flnanclng Lo Lhe flrms especlally for
Lhose whlch lndusLry speclflc flrms whlch requlre huge caplLal amounL of lnvesLmenL ln Lhe long Lerm
flxed asseL. lL has been emplrlcally found ouL LhaL ln unlLed SLaLes approx 80 of Lhe companles have
assoclaLed wlLh one or more operaLlng lease and approx amounLed Lo uSu 1.23 Lrllllons.

Welll CL ln 2006 lnvesLlgaLed and found ouL LhaL operaLlng lease can be used for predlcLlng fuLure
earnlng and fuLure sLock value. MosL operaLlng lease represenLs Lhe asseLs and llablllLles of Lhe lessee
company buL CAA speclfles LhaL operaLlng lease ls noL sLaLed ln Lhe calculaLlon of Lhe balance sheeL
excepL Lo Lhe exLenL of Lhe lease renLal.

lL has emplrlcally found ouL LhaL lncrease ln Lhe operaLlng lease would reduce Lhe earnlng poLenLlal or
fuLure proflL marglns of Lhe flrm. Also a large many research body suggesL LhaL lnvesLors mlsprlce Lhe
lmpllcaLlons of asseL growLh for fuLure earnlngs. Abarbanell and 8ushee (1998) and 1lLman eL al. (2004)
menLloned a negaLlve relaLlon beLween caplLal expendlLure and fuLure abnormal sLock reLurns. CLher
rlor research documenLs also LhaL lnvesLors mlsprlce shorL-Lerm operaLlng accruals (e.g., accounLs
recelvable) and long-Lerm operaLlng accruals.


13
lease LhaL has paymenLs equal Lo 90 percenL of an asseL's falr value wlll be classlfled as a caplLal lease and
recognlzed on Lhe balance sheeL, whlle a lease LhaL has paymenLs equal Lo 89 percenL wlll be classlfled as an
operaLlng lease
39

Cont|ngent L|ab|||ty
ConLlngenL llablllLles are expecLed fuLure llablllLles whlch are conLlngenL Lo happenlng of Lhe cerLaln
evenL. 1hese are less cerLaln Lhen Lhe provlslons and hence noL recorded ln Lhe balance sheeL buL
pracLlce ls LhaL lL should be dlsclosed ln Lhe balance sheeL as a fooLnoLe. Common Lypes of Lhe conLlngenL
llablllLy are corporaLe debL guaranLee and llablllLles on Lhe legal dlspuLes penalLles. ConLlngenL ofLen do
noL geL converLed lnLo llablllLy.
CauLlon should be Laken and lnvesLors should check ouL Lhe company should noL glve guaranLee wlLhouL
speclal and sufflclenL reason and Lhose LhaL do noL flL lnLo unusual course of Lhe buslness and Lhe
probable and maxlmum loss on all Lhe law sulLs whlch are flled agalnsL Lhe company.

1he era of off balance sheeL lLem ls sLarLed from Lhe Lnron's collapse. SLC came ouL wlLh llnanclal
release of l8-61
16
ke|ease Nos. 33-80S6, 34-4S321) whlch remlnds companles of Lhe ManagemenL
ulscusslon and Analysls 8eporL (Mu&A)as Lhey relaLe Lo llquldlLy and caplLal resources, lncludlng off
balance sheeL arrangemenL. l8-61 suggesL Lhe sLeps Lhe company should follow on order Lo meeL Lhe
dlsclosure requlremenL and furLher ln Lhe year 2003, as requlred by Sarbanes Cxley AcL of 2002 , SLC
provlded guldellnes regardlng Lhe conLenLs of Lhe Mu&A secLlon of Lhe annual reporL and release l8-
67
17
(ke|ease Nos. 33-8182, 34-47264) (SLC 2003b)
now afLer Lhe release of l8 61 and l8 67, off balance arrangemenL dlsclosure requlres speclal aLLenLlon
by Lhe managemenL, audlL commlLLee. AudlL commlLLee should ensure LhaL aparL from Lhe speclflc
dlsclosure requlremenLs of Lhe Ceneral AccepLed AccounLlng rlnclple (CAA), Mu&A ulsclosure
requlremenL have been meL wlLh respecL Lo any arrangemenL, LransacLlon, obllgaLlon wlLh an unsolldaLed
company has or ln fuLure lL may have.
1. Any obllgaLlon under a dlrecL or lndlrecL guaranLee or slmllar arrangemenL,
2. A reLalned or conLlngenL lnLeresL ln asseLs Lransferred Lo an unconsolldaLed enLlLy or slmllar
arrangemenL,
3. uerlvaLlves conLracLs, Lo Lhe exLenL LhaL Lhe falr value Lhereof ls noL fully reflecLed as a asseL or
llablllLy sldes ln Lhe flnanclal sLaLemenLs, or
4. Any obllgaLlon or llablllLy, lncludlng a conLlngenL obllgaLlon or llablllLy, Lo Lhe exLenL LhaL Lhe falr
value/full value ls noL fully reflecLed on Lhe face of Lhe flnanclal sLaLemenLs.
ln order Lo have proper dlsclosure, audlL commlLLee should have healLhy dlscusslon wlLh Lhe
managemenL Lo undersLand Lhe off balance sheeL arrangemenLs of Lhe company and whlch are requlred
Lo be dlsclosed. AudlL commlLLee whlle dlscusslng can keep Lhe followlng lssues ln focus and can ask from
Lhe managemenL:


16
l8-61 requlres company Lo dlsclose maLLers relaLlng Lo llquldlLy and caplLal resources lncludlng off-balance sheeL
arrangemenLs, cerLaln Lradlng acLlvlLles LhaL lnclude non-exchange Lraded conLracLs accounLed for aL falr value, and
Lhe effecL of LransacLlons wlLh relaLed and cerLaln oLher parLles.
17
l8 67 requlre a reglsLranL Lo provlde an explanaLlon of lLs off-balance sheeL arrangemenLs ln a separaLely
capLloned subsecLlon of Lhe "ManagemenL's ulscusslon and Analysls" ("Mu&A") secLlon of a reglsLranL's dlsclosure
documenLs. lL also requlre reglsLranLs (oLher Lhan small buslness lssuers) Lo provlde an overvlew of cerLaln known
conLracLual obllgaLlons ln a Labular formaL
40

1ab|e 4
Aud|t comm|ttee : uest|ons to the
Management
Notes
1. uescrlbe Lhe company's meLhodology for
ldenLlfylng varlable lnLeresL enLlLy18 LhaL
mlghL need Lo dlsclose ln accordance wlLh
Lhe lAS8 lnLerpreLaLlon no. 46
consolldaLlon of Lhe varlable lnLeresL
LnLlLy.

2. Are Lhere any enLlLy whlch would be
consldered as varlable lnLeresL enLlLy lf
dlfferenL sub[ecLlve lnLerpreLaLlon of Lhe
lAS8 lnLerpreLaLlon no 46 has been applled

3. Company's meLhodology ln ldenLlfylng Lhe
dlrecL and lndlrecL guaranLee ln accordance
wlLh Lhe lAS8 lnLerpreLaLlon no. 43

4. uescrlbe how many guaranLee , lncludlng
relLed charges, has been accounLed for and
how Lhey wlll be accounLed ln Lhe fuLure.

3. ls Lhe company enLered lnLo any
LransacLlon whlch lf seen lndlvldually does
noL resulL ln Lhe recognlLlon of Lhe llablllLy
buL lf seen collecLlvely would be recognlsed
as llablllLy.

6. Pas Lhe company recelved or glve any
advlce from/Lo any ouLslde parLy Lo
sLrucLure any LransacLlon Lo accompllsh Lhe
deslred flnanclal resulL. Lxplaln, lf any.

7. Pas Lhe company enLered ln any flnanclal
derlvaLlve conLracL19, whose falr value ls
noL recorded ln Lhe balance sheeL buL only
Lhe acLually value. M1M20 exposure
should also be dlsclosed ln Lhe annexure or
fooLnoLes 21

8. Pas Lhe company ls faclng any economlc
lawsulL under whlch sLaLuLe and provlslon,


18
varlable lnLeresL LnLlLy: LnLlLles whlch are noL covered under SL deflnlLlon may also need Lo dlsclose or sub[ecL
Lo Lhe lnLerpreLaLlon and Lhe some of Lhe companles whlch come ln purvlew of Lhe SL deflnlLlon may noL sub[ecL
Lo Lhe lnLerpreLaLlon and may noL be requlred Lo dlsclose. So llnanclal AccounLlng SLandard 8oard has used Lhe
Lerm varlable lnLeresL LnLlLy
19
uerlvaLlve conLracL such as futures, forwards, option, swaps instruments.
20
M1M - Mark Lo markeL ls Lhe measure of Lhe falr value of Lhe Lhe lnsLrumenL whlch keep on varlng ln accordance
wlLh Lhe Llme
21
8elevance of Lhls LransacLlon became popular ln Lhe recenL flnanclal crlses of SepLember 2008 afLer Lhe collapse
of Lhe uS lnvesLmenL banklng sLrucLure
41

lf yes, Lhan ldenLlfy Lhe maxlmum llabllLy
LhaL company may have Lo pay ln case lf
Lhe company losses hls sLand ln fronL of Lhe
[ury.

42


(646769<6=

8oberL C. MerLon. Oo tbe ptlcloq of cotpotote Jebt. 1be tlsk sttoctote of lotetest totes (1974)

xlanghon ll and xlnlel Zhao: Mocto cooomlc ffects oo cooomlc Jefoolts, Motcb 2006

Sreedhar 1 8haraLh and 1yler Shumway : lotecostloq uefoolt wltb tbe kMv-Mettoo MoJel
uecembet 17, 2004

L. CA1PCA81, L. LL-!APLL: Mul1lll ulAul15 ANu Mk1ON'5 MOul, 1oooko 8osloess 5cbool
ulscossloo lopets. 185/ul04/12 looJoo. 1oooko 8osloess 5cbool, 2004

LuWA8u l. AL1MAn: llNANclAl kA1lO5, ul5cklMlNAN1 ANAl5l5 ANu 1n lkulc1lON Ol cOklOkA1
8ANkkul1c, 1be Iootool of llNANc, 5l1M8k 1968

Ldward l. AlLman: lkulc1lNC llNANclAl ul51k55 Ol cOMlANl5. kvl5l1lNC 1n 2-5cOk ANu 21A
MOul5. Ioly 2000.

SLephen llglewskl, Pallna lrydman, and Wel[lan Llang: MoJelloq tbe ffect of Moctoecooomlc loctots oo
cotpotote uefoolt ooJ cteJlt kotloq 1toosltloos

uave CarLer, uan 8ogers and 8eLLy Slmkln: loel neJqloq lo tbe Altlloe loJostty. 1be cose of 5ootbwest
Altlloe

Moody's lnvesLors servlce: Meosotloq cotpotote uefoolt kotes

Anson 1999 and Lvans 1996) (SL)
bttp.//floJottlcles.com/p/ottlcles/ml_po5J61/ls_o6_v61/ol_o28677076/
1be AlclA AoJlt commlttee 1oolklt. CopyrlghL 2004 by Lhe Amerlcan lnsLlLuLe of CerLlfled
ubllc AccounLanLs, lnc. new ?ork, new ?ork
8arbro 8ack, 1el[a LalLlnen, kalsa Sere, Mlchlel van Wezel: cboosloq 8ooktoptcy lteJlctots osloq
ulsctlmlooot Aoolysls, loqlt ooolysls, ooJ Ceoetlc Alqotltbms, 5eptembet 1996
Cll Aharonl, ChrlsLlne 8rown, Cl Zeng : 1wo lotbs to lloooclol ulsttess, Motcb 2008
Internet keferences
hLLp://www.moodyskmv.com/newsevenLs/flles/Lul_Cvervlew.pdf

hLLp://www.ronalddomlngues.com/lndex.php?lang=&s=rlsk&ld=36

hLLp://cepa.newschool.edu/heL/proflles/merLon.hLm

hLLp://en.wlklpedla.org
43


hLLp://www.lnvesLopedla.com/

hLLp://www.answers.com/

hLLp://en.wlklpedla.org/wlkl/Z-Score
hLLp://www.nysscpa.org/cpa[ournal/old/16641866.hLm
hLLp://clLeseer.lsL.psu.edu/old/14487.hLml
hLLp://mba.Luck.darLmouLh.edu/pages/faculLy/ken.french/daLa_llbrary.hLml
hLLp://www.LrlnlLy.edu/r[ensen/accL3341/1998sp/glbson/bankrupL.hLm






44

Append|x




1ab|e S
A|| Amer|can Sem|conductor, Inc.
ears L1Dk WC1A ICk Log|t rob.
1999 0.8162 0.S261 1.618S 0.0033
2000 0.8417 0.S013 3.2230 0.0017
2001 0.8819 0.8S42 -1.3244 0.0036
2002 0.8200 0.67S3 1.3027 0.0070
2003 0.8433 0.4817 1.3671 0.01S1
2004 0.8439 0.S33S 2.18S6 0.0130
200S 0.8627 0.S690 1.1849 0.0117

1ab|e 6
App||ed extrus|on
ears L1Dk WC1A ICk Log|t rob
199S 2.0S94 0.1377 2.070S 0.0006
1996 2.S623 0.0923 2.2S40 0.0011
1997 2.2263 0.090S 8.8968 0.0008
1998 1.9491 0.0818 0.1974 0.006S
1999 1.667S 0.0916 -1.8977 0.0164
2000 0.S382 0.1401 0.7043 0.0038
2001 0.6S1S 0.1443 0.4138 0.0063
2002 0.6860 0.0847 -0.1SS9 0.0189
2003 0.6667 -0.3236 0.4671 0.047S
2004 0.0000 -0.3236 -0.2728 0.0434

43


1ab|e 7
At|as A|r
ears L1Dk WC1A ICk Log|t rob
1994 -0.797S -0.0222 2.1S89 0.0012
199S 1.9882 0.0884 2.3117 0.0006
1996 2.8S46 0.1161 2.47S3 0.0012
1997 1.8614 0.0690 1.0600 0.0029
1998 1.0772 0.0942 1.8137 0.0033
1999 0.S849 0.14S8 1.72SS 0.00S0
2000 0.4774 0.1871 1.8799 0.0028
2001 0.4600 0.19S9 -0.3299 0.0061
2002 0.2300 0.1770 -0.2919 0.0140
2003 0.0000 0.16S0 -0.0609 0.0206
2004 0.S279 -0.2694 0.S479 0.0439
200S 0.4486 0.1870 2.S98S 0.0127
2006 0.3S62 0.2342 19.9S07 0.000S
2007 0.2S80 0.2204 31.S928 0.0001


1ab|e 8
De|ta A|r
ears L1Dk WC1A ICk Log|t rob
2000 0.2801 -0.10S6 4.S921 0.0023
2001 0.319S -0.1033 -2.238S 0.0121
2002 0.3101 -0.1090 -1.3S94 0.02S7
2003 0.2879 -0.0802 -1.2087 0.0394
2004 0.S96S -0.0904 -1.7888 0.0S34
200S 0.3272 -0.0778 -1.078S 0.0329
2006 0.3317 -0.0298 0.0816 0.0247
2007 0.2463 -0.0270 1.6810 0.0192

1ab|e 9
Dura Automot|ves
ears L1Dk WC1A ICk Log|t rob
2000 0.1008 0.0704 2.S314 0.002S
2001 0.1132 0.0S88 3.9234 0.0030
2002 0.S677 0.07S6 0.0000 0.0176
2003 0.S731 0.1087 1.4689 0.0217
2004 0.S4S9 0.1130 1.0770 0.0244
200S 0.S493 0.10SS 0.9S9S 0.0199
2006 0.0018 0.12S7 -7.3863 0.0637
46



1ab|e 10
G|oba| ower equ|p grp
ears L1Dk WC1A ICk Log|t rob
1999 0.1997 -0.0740 7.2968 0.0021
2000 0.87S6 -0.0S44 0.3691 0.0061
2001 0.2093 0.0040 S.6302 0.0024
2002 0.1478 0.0927 21.200S 0.0003
2003 0.0888 0.1906 22.2168 0.0004
2004 0.2146 0.1S94 0.0742 0.0237
1996 0.7768 0.0431 17.1289 0.0000
1997 0.6199 0.0486 19.2SS7 0.0001
1998 0.S4S3 0.018S 18.0SS4 0.0002
1999 0.41S9 0.0321 0.3696 0.0069
2000 0.42S3 0.0618 -0.2842 0.0048
2001 0.S488 0.0922 -0.8891 0.0081
2002 0.6624 0.1361 -0.4721 0.0184
2003 1.1874 0.2141 -0.0891 0.0322
2004 1.3947 0.4402 -0.0S1S 0.0277
200S 1.S476 0.2393 0.1188 0.0296

1ab|e 11
Mov|e Ga||ery
ears L1Dk WC1A ICk Log|t rob
2004 0.0000 -0.0S86 43.4S20 0.0000
200S 0.0000 -0.0S27 13.7479 0.0020
2006 0.7819 -0.0678 0.7429 0.0280
2007 0.9433 -0.0801 0.7997 0.032S


1ab|e 12
kemy Int| Inc
ears L1Dk WC1A ICk Log|t rob
1998 0.S749 0.2912 1.0073 0.0023
1999 0.SSS7 0.3096 1.9S16 0.0038
2000 0.S446 0.3066 1.62S0 0.0026
2001 0.6262 0.3260 1.SS18 0.0039
2002 0.6993 0.29S4 1.1602 0.0113
2003 0.8191 0.1649 1.S274 0.0221
2004 0.8073 0.22S4 1.4447 0.0220
200S 0.8198 0.167S -0.0819 0.0247
2006 0.0209 -0.7634 -0.1414 0.0S88
47

2007 0.3376 0.0731 0.3970 0.0220


1ab|e 13
S|||con Graph|cs
ears L1Dk WC1A ICk Log|t rob
1994 0.1612 0.3S07 23.2940 0.0000
199S 0.1302 0.3SS8 16.8942 0.0000
1996 0.09S6 0.2983 7.7976 0.0001
1997 0.1112 0.332S 4.S049 0.000S
1998 0.1236 0.3707 -24.1679 0.138S
1999 6.9887 0.3297 -S.63S3 0.1963
2000 6.86S1 0.2S2S -13.6372 0.4111
2001 6.3773 0.0066 -17.4728 0.7027
2002 8.8178 0.0290 -2.4S3S 0.S27S
2003 11.4963 0.0869 -4.2049 0.88S1
2004 0.4636 0.0824 -0.9019 0.0346
200S 0.S794 0.1378 -4.S093 0.0S00
2006 0.0010 -0.0088 -S.9006 0.0S89
2007 0.2078 -0.0041 -S.6S22 0.06S6


1ab|e 14
1r|co Mar|ne
ears L1Dk WC1A ICk Log|t rob
1994 0.689S 0.01S1 1.2668 0.0018
199S 0.70S8 0.0068 0.4694 0.000S
1996 0.14S8 0.0344 7.1493 0.0002
1997 0.S143 0.0133 7.3872 0.0006
1998 0.S23S 0.0112 2.2219 0.0027
1999 16.SS66 0.00S4 -0.4916 0.909S
2000 9.S116 0.0201 0.2294 0.2009
2001 8.9709 0.0S49 0.3247 0.2183
2002 11.2146 0.0413 0.4S9S 0.6S04
2003 13.8696 -0.0079 0.6S03 0.9120
2004 0.610S -0.0494 0.9202 0.0319
200S 0.0288 0.028S 1.3023 0.016S
2006 0.0198 0.2266 -2.3406 0.023S
2007 0.2307 0.213S 9.S0S8 0.0034

48


1ab|e 1S
US a|rways
ears L1Dk WC1A ICk Log|t rob
1994 16.7611 -0.1618 0.6901 0.7434
199S 16.0S30 -0.1470 1.0631 0.3247
1996 1S.868S -0.09S6 1.6378 0.3S6S
1997 19.0273 0.0019 2.2813 0.8280
1998 13.S924 0.0423 4.S471 0.3446
1999 0.1078 -0.0202 0.7047 0.0061
2000 0.0961 -0.0400 -0.2112 0.0047
2001 0.1177 -0.0983 -S.6667 0.0203
2002 0.0972 -0.0343 -1.72S0 0.0226
2003 0.0766 -0.0024 -0.060S 0.0266
2004 0.4339 0.0296 -1.037S 0.037S
200S 0.4012 -0.0101 S.707S 0.0093
2006 0.3837 0.03S8 1.9S2S 0.0166
2007 0.3770 0.0894 -1.94S1 0.0330

1ab|e 16
W|nn D|x|e Stores
ears L1Dk WC1A ICk Log|t rob
2002 0.1040 0.1677 S.9421 0.0044
2003 0.1117 0.1764 7.49S8 0.00SS
2004 0.1200 0.16SS 0.6033 0.0206
200S 0.1288 0.3073 -3.2362 0.026S
2006 0.0034 0.3827 -10.3S37 0.07S8
2007 0.0110 0.2S38 -2.9026 0.0268