Who developed a model for predicting bankruptcy by using financial ratios ?

Question

Accepted Answer

The correct option is 2:
The correct answer is Edward Altman, an American finance professor who developed the famous **Altman Z-Score** model. This seminal model was first published in 1968 and is widely considered the standard for predicting corporate financial distress or bankruptcy. The Z-Score uses a multivariate statistical technique, specifically Multiple Discriminant Analysis, to combine five key financial ratios from a company’s balance sheet and income statement—such as Working Capital/Total Assets and Retained Earnings/Total Assets—into a single score. This score serves as a powerful indicator of a company's financial health, with lower scores indicating a higher probability of bankruptcy, typically within two years. The model's enduring accuracy and practical application have made it the benchmark against which most other failure prediction models are measured.

The incorrect option is 1:
John C. Hull is an extremely well-known and highly respected authority in the field of **financial derivatives and risk management**. His major contribution is his influential textbook, "Options, Futures, and Other Derivatives," which is a core resource for students and practitioners worldwide. Hull’s work primarily focuses on the pricing and hedging of complex financial instruments, such as the Hull-White model for interest rates. He is not credited with developing the classic, ratio-based model for predicting corporate bankruptcy. Therefore, his expertise lies in quantitative finance rather than in fundamental financial statement analysis for insolvency prediction.

The incorrect option is 3:
The names "Smith and Staple" are not associated with any of the foundational and universally recognized models for predicting corporate bankruptcy using financial ratios. While many researchers have contributed to the general field of financial analysis, the landmark, multivariate ratio-based model that became the industry standard and is frequently tested on is the Altman Z-Score. This option is a distractor as these individuals have no comparable, seminal model in this specific area of financial analysis.

The incorrect option is 4:
John Lintner is a pivotal figure in the history of modern finance, but his core academic contributions lie in entirely different domains. He is most famous for his pioneering work in developing the **Capital Asset Pricing Model (CAPM)**, which is used to determine the theoretically appropriate required rate of return of an asset, given its risk. Additionally, he developed a classic model describing corporate dividend policy. His research focused on risk and return in asset pricing and corporate payout decisions, not on a model for classifying and predicting corporate insolvency.