CHAPTER NO 04

Market for Credit

The credit market involves two main players:

• Demand for credit: This is from companies needing money for different reasons like daily
operations, investments, or managing finances.
• Supply of credit: This comes from entities like banks, creditors, private lenders, and public
debt investors who provide the money companies need.
In simple terms, when a company borrows money (credit), it pays back more than it borrowed
due to interest rates set by lenders and market conditions.

DEMAND OF CREDIT
Credit Demand for Operating Activities
key points about credit demand for operating activities and credit terms:

• Credit terms are based on past experience: Lenders decide how much credit to offer a
company based on their history of borrowing and repayment to check credit worthiness.
• Routine, low-risk needs: Companies often borrow for everyday needs like buying
materials or paying for labor, which are predictable and relatively safe for lenders. (lender
k liye asani hai inshort)
i. Advance seasonal purchases: Some companies borrow ahead of busy seasons to stock up
on inventory or prepare for increased demand.
• Higher risk credit: If a company needs credit to cover losses or is in a riskier financial
situation, lenders may charge higher interest rates or offer less favorable terms (lender
apni safety k liye high interest charge krega)
willing creditor a lifeline for a company. They're like a helping hand that gives the company the
money it needs to keep going. Without this support, the company might not be able to pay its
bills or keep running, which could lead to bankruptcy, meaning it would have to shut down. So,
a willing creditor can really make a big difference in keeping the company afloat and letting it
continue its business.

Credit Demand for Investing Activities:

• When businesses want to invest in things like new equipment or joining with other
companies (which we call mergers), they often need a lot of money upfront.
• These needs aren't always the same because they may occur for different amounts and
at different times.
• To get this money, companies often use long-term loans. These are debts that they pay
back over a long time, which helps them get started and grow.

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• For older, more established businesses, their spending on big projects tends to follow a
pattern, so it's easier to predict when they'll need money for these kinds of things.

Credit Demand for Financing Activities

happens when a company needs money for specific things like paying off loans, giving dividends
to shareholders, or buying back its own stock.
• It's not as common as other types of financial activities, like running the business
(operating activities) or buying and selling assets (investing activities).
• Some common situations where companies need this kind of credit include when a loan
or bond is due, but they don't have enough money saved up to pay it back. Another
situation is when they want to give dividends to shareholders or buy back their own
stock, but they don't have the cash, so they borrow money to do it.
• Evergreen debt is a term for when a company keeps paying off old debts by taking on
new ones. It's like using one credit card to pay off another, which can be risky because it
means the company is always in debt, and it can be harder to get out of that cycle.

1. Operating Activities:
- Day-to-day business expenses like buying inventory, paying employees, and selling
products/services.
- Constant need for cash flow to keep the business running smoothly.
2. Investing Activities:
- Buying and selling assets like property, equipment, or investments.
- Requires larger sums of money for long-term growth and development.
3. Financing Activities:
- Obtaining funds through loans, bonds, or equity to support operations or investments.
- Used
for specific financial needs like paying off debts, giving dividends, or buying back stock.

SUPPLY OF CREDIT
Trade credit:
Trade credit is like a loan but from suppliers. It's when a business buys goods or services from a
supplier but pays for them later, usually within a set period.
No Extra Charges
Unlike a regular loan, trade credit usually doesn't have any extra charges like interest. It's more
like a friendly agreement between the business and the supplier.
Tailored Terms
Suppliers can customize the payment terms based on how trustworthy they think the business
is. For example, a long-standing customer might get better payment terms than a new one.
(based on how good you are in paying back money)

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Credit Limit
Just like a credit card has a limit, trade credit also has a limit. This is the maximum amount of
goods or services a business can buy on credit from that supplier.

Bank Loans:
Money borrowed from a bank to fit your needs, with rules set by regulators. Bank loans are a
significant part of the overall supply of credit because they provide individuals and businesses
with access to funds they might not otherwise have.
• Revolving Credit Line: Like a flexible loan where you can borrow when needed, paying
interest only on what you use.
• Lines of Credit: Like the above, offering a preset amount of money you can use whenever
required.
• Letters of Credit: A bank steps in to guarantee payment between two parties, often in
international transactions.

More Bank Loans

• Term Loans: Set amount borrowed with regular payments overtime, with fixed or
changing interest rates.
• Mortgages Loans: for buying property, where the property acts as security if you can't
repay the loan. A mortgage is a loan from a bank that helps you buy a house, and you pay
it back over time with interest.

Nonbank Private Financing:

• When banks don't lend money, businesses turn to private sources for financing. These
sources are not banks but could be private equity firms that know the industry well.
• Private lenders, like private equity firms, step in. They understand the business and can
offer unique ways to pay back loans. Sometimes, they also give advice like a consultant.
It’s used when traditional banks can't help.
• Private lenders have expertise and can be flexible with repayment terms, making them a
good option for businesses in need of funding when banks aren't an option.

Lease Financing
• Purpose: Used for acquiring big equipment without buying it outright.
• Items: Machinery, computer gear, vehicles.
• Structure: Agreement between leasing firm (owner) and lessee (user) on payment terms,
duration, and end-of-lease options.
• Collateral: Possible requirement for security. The leasing firm might ask for something as
security, called collateral, in case the lessee can't make their payments.

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• Credit Risk: Leasing firm assesses lessee's ability to pay and history of debt repayment.
Leasing firms check lessees' credit history and financial capability to gauge the risk of
granting the lease.

Publicly Traded Debt:

Money borrowed from the public through public markets.
• Commercial Paper: Short-term borrowing allowed by SEC rules, lasting up to 270 days.
• Bonds or Debentures: Long-term public borrowing regulated by the SEC.
i. Payment Structure: Borrowed money repaid over a fixed term with regular interest
payments, either twice a year (semi-annual) or once a year (annual).

Credit Risk Analysis Process

Purpose:
The goal is to figure out how much money a lender might lose if someone they lent
money to can't pay it back. This helps lenders make smarter decisions about who to lend
money to.
Components:
Expected Credit Loss (ECL): This is how much money the lender expects to lose. It's
calculated by multiplying two things:
Expected credit loss =Chance of default x Loss given default
• Chance of Default: This is about how likely it is that the person borrowing money
won't be able to pay it back. It's kind of like asking, "How good are they at
repaying debts?"
• Loss Given Default (LGD): This is about how much money the lender might lose if
the borrower can't pay back the money. It's like saying, "If they can't pay, how
much of the loan won't we get back?"
Breaking Down Chance of Default:
It's about looking at how capable the person is of repaying their debts. For example, do
they have a steady job? Do they have a history of paying bills on time?
Breaking Down Loss Given Default:
This is about figuring out how much money the lender might lose if the borrower can't
pay. For instance, if the borrower has valuable assets, the lender might not lose as much.
So, credit risk analysis is like a tool that helps lenders understand the chances of losing
money when they lend it out. It's a way to make lending decisions based on knowing the
risks involved.

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Credit Raters
Credit rating agencies are like financial detectives who investigate how likely it is that a
company or government will pay back the money they borrow. Here’s how they work:
• They assess credit risk: This means they figure out how risky it is to lend money to a
particular company or government.
• Different from lenders: Unlike banks or other lenders who give out money, credit rating
agencies just give opinions about how safe it is to lend money to different borrowers.
• No direct financial involvement: They don’t lend money themselves, so they’re not
rooting for any specific outcome. They can focus on giving honest opinions about credit
risk without worrying about their own profits.
• Access to more, better, and current info: They have access to lots of information about
companies and governments, which helps them make more accurate predictions about
credit risk.
• Refine risk analysis across industries: They use their experience and data to compare
different types of borrowers, like comparing a tech company to a car manufacturer, to
see which one is more likely to pay back loans on time.
Overall, credit rating agencies are like expert judges who help lenders make smart decisions
about who to lend money to.

Credit Analysis
Step 1: Understanding the Loan
First, we need to figure out why someone needs the loan. Loans can be used for different
reasons, like managing ups and downs in cash flow, covering temporary losses, buying big
things like equipment or companies, or changing how a company is financed.
Step 2: Assess macroeconomic environment and industry conditions.
Next, we check out the overall economic situation and the industry the borrower is in. We think
about things like how much competition there is, whether customers can push for lower prices,
if suppliers can ask for more money or early payments, and if there's a risk of new competitors
entering the market.
Step 3: Checking the Numbers
Then comes the financial check-up. We dive into the company's financial statements and do
some math to understand how well they're doing financially. We look at things like how
efficient they are in using their assets, how much profit they make compared to what they
spend, and how they manage their money day-to-day.
Step 4: Predicting the Future
Finally, we try to predict what might happen next. We use all the information from the previous
steps to guess how likely it is that the borrower will pay back the loan in the future. We
consider ongoing trends, risks, and opportunities that could affect their ability to repay.

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