mation Hand, Holthausen and Leftwich (1992) found that unanticipated ratings changes are associated with significant bond and share price effects, especially when bonds are being downgraded.Bankruptcy Prediction Creditors and equity investors alike are interested in knowing the likelihood of a firm experiencing financial distress A high probability of distress indicates both debt and equity are risky Investors factor this information into portfolio decisions Lenders use the financial information in lending decisions Therefore bankruptcy prediction is useful in an efficient capital market Beaver (1966) and Altman(1968) conducted early work on bankruptcy prediction They found that economically intuitive ratios like leverage, earnings before interest and tax over assets and working capital over assets are useful indicators of financial distress Altman’s models and his Zeta scores have been popular in the financial community due to their high degree of predictive accuracy Ohison disagrees with these models arguing their predictive ability is over-rated due to sample issues Altman and Spivack have compared the Zeta approach and the Value Line approach and conclude the models rank similarlyEquity Risk The most common measure of equity risk is the CAPM Beta One way of estimating the expected rate of return on equity is to add the risk free rate to an allowance for the risk, equal to the Beta times the estimated risk premium The limitation of market return and accounting Betas is that they are obtained using historical data and therefore may be less useful Rosenberg and Guy (1976) give examples of macroeconomic events like energy crises, inflation, etc and their impacts on Beta Lev (1974) shows that changes in a firm’s operating leverage should be positively associated with Beta risk changes Ball, ...
