FINANCIAL MODELING

Firm's Returns in Credit Risk

Firm's Returns in Credit Risk

Introduction

The paper focuses on the firm's returns in credit risk which particularly focuses on Goodcredit, a client of PMC Inc. which provides loans and financial services to both individuals and companies. The firm's returns in credit risk is based on the multi-factor model which is appropriate for Goodcredit as there are various factors that affect Goodcredit's portfolio returns. For that reason, in spite of focusing on a particular factor, various factors are considered in the study that include industry, size, price to book ratio, market return and geographical regions for firm's returns in credit risk as it will guide Goodcredit in making efficient portfolio of companies comprises of firms whose returns are high.

Traditionally, it is observed that in modeling the firm return in credit risk, a single-factor model is used to model the firm's returns. However, in this study of Goodcredit's portfolio of firm, the multi-factor model is used as the multi-factor model provides a framework for asset allocation, investment analysis, and discipline. It brings order and clarity in the investment process of firms like Goodcredit that identifies and explains the forces that drive the returns of a portfolio.

Research Questions

Are means equal for firms return and industry sectors?

Are means are equal for firms return and industry sectors?

Is there association between firms return and market return?

Does size of the firm impact firms return?

Does price to book ratio of the firms impact firms return?

Hypotheses

H 1: The monthly return of firms is dependent on different industry sectors.

H 2: The monthly return of firms is dependent on different geographical regions where the firm mainly operates.

H 3: There is correlation between monthly firm return and monthly market return of firms.

H 4: There is a relationship of monthly firm return with size of the firm.

H 5: There is a relationship of monthly firm return with price to book ratio.

Variables

In the study of factor models on explaining firm's returns in credit risk, following variables are incorporated in the study;

Size include the total assets of the firms;

P/B shows the price to book ratio which reflects the firm's share price divided by the firm's book value;

Firm return; which is based on the monthly firm return for a chosen period;

Regionincludes the geographical regions where the firm operates, it include America, Europe and Asia;

Market return; which is based on the monthly market return;

Industry; it is the industry in which the firm operates, it include consumer, manufacturing, high tech, health and other.

Discussion and Analysis

In relation to firm's returns in credit risk, effective management of the Goodcredit's portfolio returns often requires an assessment of the credit risks which are associated with the multiple factors such as monthly market return, industry sector in which the firm competes and geographical region where the firm mainly operates, price to book ratio and size that reflects total assets. In addition to a single market factor, as suggested by the past researchers, an evaluation of return on assets which shows firm's returns in a credit ...