Question
What is the importance of the term “Interest Coverage Ratio” of a firm in India?
1. It helps in understanding the firms that a bank is going to give loan to.
2. It helps in evaluation the emerging risk of a firm that a bank is going to give loan to.
3. The higher a borrowing Firm’s level of interest coverage ratio, the worse is its ability to service its dept.
Select the correct answer using the code given below :
(a) 1 and 2 only
(b) 2 only
(c) 1 and 3 only
(d) 1, 2 and 3
Answer:
A
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Explanation:
The interest coverage ratio is an important financial metric used by banks and financial institutions to assess the creditworthiness of a firm and its ability to service its debt. A higher interest coverage ratio indicates that a firm is generating sufficient earnings to cover its interest payments, which is seen as a positive indicator of financial health.
1. Statement 1 is correct: Banks use the interest coverage ratio to assess the ability of a firm to repay its loans. A higher interest coverage ratio gives confidence to the bank that the firm has enough earnings to meet its interest obligations.
2. Statement 2 is correct: The interest coverage ratio provides insight into the financial risk associated with a firm's debt. A lower interest coverage ratio indicates a higher risk of defaulting on interest payments, which is a concern for banks when considering loan approvals.
3. Statement 3 is incorrect: A higher interest coverage ratio signifies a better ability to service debt, not worse.