CFI CBCA CORE FINAL SCRIPT 2026
ASSESSMENT QUESTIONS ANSWERS
COMPLETE EXAM PREP A+
◉ Default Prediction and Options Theory
Default risk can be estimated using principles of option theory
Answer: Can look at the equity of a firm as a call option on the firm's
underlying assets.
If the firm performs badly, the equity holders do not exercise their
call options (the price of the option being the face value of the debt)
and therefore allow ownership of the firm effectively to transfer to
the debt holders.
Default is effectively the exercise of a put option by shareholders -
transferring assets to the debt holders.
The value of the put option, and probability of it being exercised, are
effective measures of default risk. Assume debt is due for
redemption:
◉ Market value of assets > Face value of debt... Firm will not
default...
, Answer: Shareholders will liquidate enough assets to pay off debt.
◉ Market value of assets < Face value of debt... Firm will default...
Answer: Shareholders will exercise their put options to transfer
assets to the debt holders.
◉ The Expected Default Frequency (EDF)
Moody's EDF model uses 3 stages to calculate expected default
frequency:
Answer: 01Calculate the market value and volatility of the firm's
shares
02The default point (based on the firm's liabilities) 03The expected
value of the firm (based on current firm value and volatility)
◉ The Expected Default Frequency (EDF) Model
EDF also calculates a distance-to-default, which is the number of
standard deviations the firm's expected value must drop to reach the
default point.
Answer: Moody's has determined that the most frequent default
point is where:
Value of Firm = Current Liabilities + (0.5 x Long-Term Liabilities)
◉ The Expected Default Frequency (EDF) Model
01 How useful is Moody's distance-to-default?
ASSESSMENT QUESTIONS ANSWERS
COMPLETE EXAM PREP A+
◉ Default Prediction and Options Theory
Default risk can be estimated using principles of option theory
Answer: Can look at the equity of a firm as a call option on the firm's
underlying assets.
If the firm performs badly, the equity holders do not exercise their
call options (the price of the option being the face value of the debt)
and therefore allow ownership of the firm effectively to transfer to
the debt holders.
Default is effectively the exercise of a put option by shareholders -
transferring assets to the debt holders.
The value of the put option, and probability of it being exercised, are
effective measures of default risk. Assume debt is due for
redemption:
◉ Market value of assets > Face value of debt... Firm will not
default...
, Answer: Shareholders will liquidate enough assets to pay off debt.
◉ Market value of assets < Face value of debt... Firm will default...
Answer: Shareholders will exercise their put options to transfer
assets to the debt holders.
◉ The Expected Default Frequency (EDF)
Moody's EDF model uses 3 stages to calculate expected default
frequency:
Answer: 01Calculate the market value and volatility of the firm's
shares
02The default point (based on the firm's liabilities) 03The expected
value of the firm (based on current firm value and volatility)
◉ The Expected Default Frequency (EDF) Model
EDF also calculates a distance-to-default, which is the number of
standard deviations the firm's expected value must drop to reach the
default point.
Answer: Moody's has determined that the most frequent default
point is where:
Value of Firm = Current Liabilities + (0.5 x Long-Term Liabilities)
◉ The Expected Default Frequency (EDF) Model
01 How useful is Moody's distance-to-default?
