A Likelihood Ratio (LR) test is calculated to compare the log-likelihood of the two models. The LR value is calculated as 2.74 with a p-value of 25.5%.

a. Calculate the t-ratio for each factor in Model A. (20% question weight)

b. Describe the impact of each factor of probability of default in Model A and if the relationships are as expected. (20% question weight)

c. Explain the overall fit of the models and how well it predicts default. (30% question weight)

d. Discuss which model you would choose to calculate the probability of default of corporate firms and give a rationale for including OR excluding the RE/TA and ME/TL from the model.

QUESTION 2 ANSWER ALL PARTS The following logit model has been produced to calculate the probability of default of corporate fins Model A: Constant WC/TA RE/TA ME/TL S/TA EBIT/TA -7.59 Coefficient 3.26 0.31 -1.57 -0.28 0.60 0,21 0.55 0.19 2.40 0.11 Standard error of the coefficient 0.35 T-ratio p-value 0.00 0.58 0.00 0.00 0.02 0.09 Where: WC/TA is Working capital/Total assets RE/TA IS Retained earnings/Total assets EBIT/TA is Earnings before interest and taxes/Total assets ME/TL is market value of equity/Total liabilities SATA is Sales/ Total assets The Pseudo-R2 for this model is 12% and the likelihood Aatio (LR) test is 102, which is significant at the 1% level. The insignificant factors WC/TA and S/TA are removed from Model A and the following logit model is produced. Model B. Constant RE/TA EBIT/TA ME/TL Coefficient 3.07 -1.56 -6.91 -0.28 0.18 0.19 2.40 0.11 Standard error of the coefficient p-value 0.00 0.00 0.00 0.01 The Pseudo-R2 for this mogel is 10% and the likelihood Ratio (LR) test is 100, which is significant at the 1% level. QUESTION 2 ANSWER ALL PARTS The following logit model has been produced to calculate the probability of default of corporate fins Model A: Constant WC/TA RE/TA ME/TL S/TA EBIT/TA -7.59 Coefficient 3.26 0.31 -1.57 -0.28 0.60 0,21 0.55 0.19 2.40 0.11 Standard error of the coefficient 0.35 T-ratio p-value 0.00 0.58 0.00 0.00 0.02 0.09 Where: WC/TA is Working capital/Total assets RE/TA IS Retained earnings/Total assets EBIT/TA is Earnings before interest and taxes/Total assets ME/TL is market value of equity/Total liabilities SATA is Sales/ Total assets The Pseudo-R2 for this model is 12% and the likelihood Aatio (LR) test is 102, which is significant at the 1% level. The insignificant factors WC/TA and S/TA are removed from Model A and the following logit model is produced. Model B. Constant RE/TA EBIT/TA ME/TL Coefficient 3.07 -1.56 -6.91 -0.28 0.18 0.19 2.40 0.11 Standard error of the coefficient p-value 0.00 0.00 0.00 0.01 The Pseudo-R2 for this mogel is 10% and the likelihood Ratio (LR) test is 100, which is significant at the 1% level