How can structural models be used by bond portfolio managers?
What will be an ideal response?
In making credit decisions, structural models have been used bond portfolio managers (and other entities such as banks for that matter) in one or more of the following ways:
to estimate a corporate bond's default risk;
to predict rating changes (with particular interest in downgrades);
to forecast changes in corporate bond credit spreads;
to identify relative value opportunitieswithin the corporate bond market;
to identify relative value opportunities for a firm with several issues; and,
to evaluate the sensitivity of corporate bond credit spreads to equity prices.
In assessing the merits of structural models, these potential uses must be kept in mind. Structural models may perform well in one area of application in bond portfolio management but turn out to be useless for other applications. When considering the potential use of structural models, it is important to be aware of the underlying assumptions of the model because it is these assumptions that may limit the usefulness of a model.
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