## Friday, February 08, 2008

### NY professor sees junk bond defaults at 4.64 percent: report | Reuters

It is not every day that the Altman Z score is in the news, so when I saw that it was today I figured it had to be mentioned.

NY professor sees junk bond defaults at 4.64 percent: report | Reuters:
"A New York University professor is projecting that high-yield 'junk' bonds will default at a rate of 4.64 percent this year, the highest since 2003, The Wall Street Journal reported on Wednesday. "
Don't remember what the Altman Z score is? You have much company. If past classes are to be a guide, it is one of the most easily forgotten ratios that we cover.

The Altman-Z score is a ratio, or more correctly a model based off of several ratios each being given different weights, that is used to predict bankruptcy.

One look-in:

"In 1966 Altman selected a sample of 66 corporations....Altman calculated 22 common financial ratios for all 66 corporations. (For the bankrupt firms, he used the financial statements issued one year prior to bankruptcy.) His goal was to choose a small number of those ratios that could best distinguish between a bankrupt firm and a healthy one.

To make his selection Altman used the statistical technique of multiple discriminant analysis. This approach shows which characteristics in which proportions can best be used for determining to which of several categories a subject belongs: bankrupt versus nonbankrupt, rich versus poor, young versus old, and so on.""

What does the Z-score look like? There are different versions out there, but essentially they based the score off of a combination of profitability (EBIT/Total Assets), revenue (Sales/Total assets), Liquidity (Working capital/Total assets), leverage (either Times interest earned or other similar measure). Some versions also include volatility of earnings as well.

Both the Exceluser article and this article from Value Based Management list the formula.

Of course any model has its limitations as this article from Business Week on credit scores (which are similar to Z scores in spirit) mentions.

#### 1 comment:

guitarrich said...

Great post! I am talking about Bankruptcy prediction in my class this week.