Financial Terms related to Credit This document is part of the valuable contents available at www.ftpall.com, a free online glossary with more than five thousand financial and business terms. This document can be copied and distributed freely Find thousands of financial terms at www.ftpall.com respecting its original format. It is forbidden its transcription, translation or change on its format without authorization of its author or editor. CREDIT Ach automated clearinghouse credits • Deposits of payroll directly into the payees' (employees') accounts. Sacrifices disbursement float but may generate goodwill for the employer. Best interests of creditors test • The requirement that a claim holder voting against a plan of reorganization must receive at least as much as he would have if the debtor were liquidated. Comparative credit analysis • A method of analysis in which a firm is compared to others that have a desired target debt rating in order to infer an appropriate financial ratio target. Consumer credit • Credit granted by a firm to consumers for the purchase of goods or services. Also called retail credit. Credit www.ftpall.com 2|Page • Money loaned. Credit analysis • The process of analyzing information on companies and bond issues in order to estimate the ability of the issuer to live up to its future contractual obligations. Related: default risk • The evaluation of credit applicants. Credit crunch Find thousands of financial terms at www.ftpall.com • Occurs when credit availability is so restricted that normal economic or financial activity is adversely impacted. It is a more extreme case of credit rationing which has tightened. • If depositors in one location (say Michigan) cannot provide deposits to fund loans in another location (say California), many good loans may go unfunded. This is a credit crunch. Credit enhancement • The backing of paper with collateral, a bank LOC, or some other device to achieve a higher rating for the paper. The firm that securitizes mortgages guarantees against defaults on the underlying pool. This is called credit enhancement. • Purchase of the financial guarantee of a large insurance company to raise funds. Credit monitoring • The ongoing review of a firm's accounts receivable to determine whether customers are paying according to the stated credit terms. Credit period • The number of days after the beginning of the credit period until the payment of the account is due. www.ftpall.com 3|Page • The length of time for which the customer is granted credit. Credit policy • The determination of credit selection, credit standards, and credit terms. Credit rating services • Refers to companies that rate public, private or consumer credit ratings. The primary credit rating companies for sovereign or country and corporate ratings are: Duff and Phelps Credit Rating Company, Moodys, andStandard and Poors. For Find thousands of financial terms at www.ftpall.com consumer scoring a major company is Fair, Isaac. Credit rationing • Occurs when the terms a borrowing relationship become more restrictive. For example, higher margin requirements for security transactions indicates tighter credit requirements. Sometimes, credit rationing may occur in some industries and not in others to promote or discourage specific types of activities. Credit rationing can occur when interest rates have been trending either up or down. In the latter, defaults often prompt new and higher margin requirements. Thus, credit availability is more limited and interest rates can move higher in the near term as cash demands increase. Credit risk • The risk that an issuer of debt securities or a borrower may default on his obligations or that the payment may not be made on a negotiable instrument. Related: Default risk • Is the risk related to counterparty failure. It is a key concern for Over-the-Counter transactions. This compares to listed trades passing through a clearinghouse. • Credit risk refers to the possibility that borrowers sometimes default on their promises. The risk that an issuer of debt securities or a borrower may default on his www.ftpall.com 4|Page obligations, or that payment may not be made on sale of a negotiable instrument. (See overnight delivery risk.) Credit scoring • A statistical technique wherein several financial characteristics are combined to form a single score to represent a customer's creditworthiness. • A credit selection method commonly used with high-volume/small dollar credit requests; relies on a credit score determined by applying statistically derived weights to a credit applicant's scores on key financial and credit characteristics. Find thousands of financial terms at www.ftpall.com Credit scoring models • These are quantitative models that predict bankruptcy. They establish which factors are important with regard to credit risk. They evaluate the relative importance of these risk factors, improve the estimation of default probability, automate the rejection of bad loan applicants, and improve the pricing of the loan. They also help calculate any potential future loan losses and possible revenues. Credit selection • The decision whether to extend credit to a customer and how much credit to extend. Credit spread • Is an option position whereby the end result is a credit. For example, the investor who places a vertical bear call spread receives a credit. Similarly, the trader who places a vertical bull put spread receives a premium credit. • Related: Quality spread Credit standards • The minimum requirements for extending credit to a customer. Credit terms www.ftpall.com 5|Page • The terms of sale for customers who have been extended credit by the firm. Crediting rate • The interest rate offered on an investment type insurance policy. Creditor • Lender of money. Demand line of credit • A bank line of credit that enables a customer to borrow on a daily or on-demand Find thousands of financial terms at www.ftpall.com basis. • A bank line of credit that enables a customer to borrow on a daily or an on-demand basis. Eurocredits • Intermediate-term loans of Eurocurrencies made by banking syndicates to corporate and government borrowers. Evergreen credit • Revolving credit without maturity. Federal credit agencies • Agencies of the federal government set up to supply credit to various classes of institutions and individuals, e.g. S&Ls, small business firms, students, farmers, and exporters. • Agencies of the federal government set up to supply credit to various classes of institutions and individuals; for example, S&Ls, small business firms, students, farmers, farm cooperatives, and exporters. • Agencies of the Federal government set up to supply credit to various classes of institutions and individuals, e.g., S&L's, small business firms, students, farmers, farm www.ftpall.com 6|Page cooperatives, and exporters. Five c's of credit • The five key dimensions--character, capacity, capital, collateral, and conditions-- used by a firm's credit analysts in their analysis of an applicant's creditworthiness. Five cs of credit • Five characteristics that are used to form a judgement about a customer's creditworthiness: character, capacity, capital, collateral, and conditions. Find thousands of financial terms at www.ftpall.com Foreign tax credit • Home country credit against domestic income tax for foreign taxes paid on foreign derived earnings. Four c's of credit • The four key dimensions of credit character, capacity, capital, and conditions used by credit analysts to provide a framework for in-depth credit analysis. Full faith and credit obligations • The security pledges for larger municipal bond issuers, such as states and large cities which have diverse funding sources. Investment tax credit • Abbreviated ITC. An incentive for businesses in various regions of the country to purchase certain types of assets or undertake certain types of research and development activities; results in a direct reduction of federal taxes that would otherwise be payable. • Proportion of new capital investment that can be used to reduce a company's tax bill (abolished in 1986). Letter of credit l/c • A letter written by a company's bank to the company's foreign supplier, stating that www.ftpall.com 7|Page the bank guarantees payment of an invoiced amount if all the underlying agreements are met. • A form of guarantee of payment issued by a bank used to guarantee the payment of interest and repayment of principal on bond issues. Letters of credit • Letters of Credit (LC) is an example of OBSAs (Off-Balance Sheet Activities). LC simply says that if a firm cannot make a promised payment within say 90 days, the bank will make the payment. There is no immediate liability that shows up on the Find thousands of financial terms at www.ftpall.com balance sheet and the bank earns a fee income for the guarantee. Line of credit • An agreement between a chartered bank and a business specifying the amount of unsecured short-term borrowing the bank will make available to the firm over a given period of time. • An informal arrangement between a bank and a customer establishing a maximum loan balance that the bank will permit the borrower to maintain. • An arrangement by which a bank agrees to lend to the line holder during some specified period any amount up to the full amount of the line. Retail credit • Credit granted by a firm to consumers for the purchase of goods or services. See: consumer credit. Revolving credit agreement • A line of credit guaranteed to a borrower by a chartered bank regardless of the scarcity of money. • A legal commitment wherein a bank promises to lend a customer up to a specified maximum amount during a specified period. www.ftpall.com 8|Page Revolving line of credit • A bank line of credit on which the customer pays a commitment fee and can take down and repay funds according to his needs. Normally the line involves a firm commitment from the bank for a period of several years. • A bank line of credit on which the customer pays a commitment fee and can take down and repay funds according to his needs. Normally the line involves a firm commitment from the bank for a period of several years. Secured creditors Find thousands of financial terms at www.ftpall.com • Creditors who have specific assets pledged as collateral and in liquidation of the failed firm receive proceeds from the sale of those assets. Standby letters of credit slc's • These provide default guarantees to back a commercial paper issue or a municipal revenue bond. They also provide performance bond guarantees to ensure that a real-estate development will be operational within a stated time period. They involve much larger amounts than the typical letters of credit. Trade credit • Credit granted by a firm to another firm for the purchase of goods or services. Unsecured, or general, creditors • Creditors who have a general claim against all the firm's assets other than those specifically pledged as collateral.