What does the default point in the Moody's-KMV EDF Model represent?

In the context of the Moody's-KMV Expected Default Frequency (EDF) Model, the default point represents a critical threshold below which a firm is considered to be at risk of defaulting on its obligations. This point is essential in assessing the firm’s financial stability and likelihood of default.

The correct interpretation is that the default point is defined as all short-term debt plus half of the long-term debt. This definition serves to capture the total liabilities that are most immediately relevant in the context of potential default. Short-term debt is typically due within a year, and thus it represents the more pressing commitment for the company. Adding half of the long-term debt to this calculation acknowledges that while these obligations are not due in the short term, a portion of them still contributes to the financial pressure the company may face, especially if the firm's cash flow does not support its long-term capital commitments.

This approach provides a more comprehensive understanding of a company’s total liabilities that are likely to contribute to its risk of default, as it reflects both the immediate and some future obligations.