Fixed Income Investments - Credit Risk

1. Default Risk - Default risk is the risk that the issuer will go belly up and not be able to pay its obligations of interest and principle. To help measure this risk, an investor can look at default rates. A default rate is the percentage of a population of bonds that are expected to default. Another ratio that an investor can look at is the recovery rate. This rate indicates how much and investor can expect to get back if a default occurs.

2. Credit Spread Risk - This second type of credit risk deals with how the spread of an issue over the treasury curve will react. For example, Ford five-year bonds may trade at 50 basis points above the current five-year treasury. If the five-year bond is trading at 3.5%, then the Ford bonds are trading at a yield of 4%. If this spread of 50 bps widens out compared to other bond issues, it would mean that the Ford bonds are not performing as well as the other bonds in the marketplace. Spreads tend to widen in poor performing economies.

3. Downgrade Risk - The third type of credit risk deals with the rating agencies. These agencies, such as Moody's, S&P and Fitch, give an issuer a rating or grade that indicates the possibility of default. On the more secure side, the ratings range from AAA, which is the best rating to AA, A, BBB. These are the ratings for investment-grade bonds. Once bonds dip into the BB, B, CCC ranges they become junk bonds or, in politically correct language, high yield securities. If one of these rating agencies downgrades a company's rating, it may be harder for the corporation to pay. This will typically cause its marker value to decrease. That is what this risk is all about.

Liquidity Risk
Related Articles
  1. Personal Finance

    Invest in Costco? First Understand Its Balance Sheet

    A strong balance sheet sets a company apart and boosts investor confidence. How healthy is Costco based on an analysis of its balance sheets from the last two years?
  2. Investing Basics

    Brokers and RIAs: One and the Same?

    Brokers and registered investment advisors have some key differences. Here's what you need to know.
  3. Professionals

    DCF Vs. Comparables: Which One To Use

    DCF and Comparables models are widely used in equity valuation. We explain the pros and cons of each method.
  4. Professionals

    How To Make Money Using Tobin's Q Ratio

    Although it seems simple, Tobin's Q Ratio is more complex than it appears. We explore some of its main strengths and weaknesses.
  5. Taxes

    3 Secrets You Didn't Know About Estate Planning

    Every advisor and saver needs to know these three estate planning secrets.
  6. Professionals

    Cash Flow Is King: How to Keep it Running

    Why is cash flow so important, and what steps can a business take to improve it?
  7. Entrepreneurship

    10 Ways to Nurse Cash Flow in Healthcare

    Running a business in healthcare? You might want to rethink cash flow management practices.
  8. Professionals

    How to Help Clients with Cash Flow Issues

    Sometimes your spending gets out of hand or income has a hiccup. Here's how financial advisors can help clients who have cash flow issues.
  9. Professionals

    How to Improve Your Cash Flow in Manufacturing

    Here are 10 ways to to improve a manufacturer's cash flow.
  10. Professionals

    10 Ways to Improve Cash Flow in Construction

    Improving cash flow in construction requires some sector-specific strategies.
RELATED TERMS
  1. Personal Financial Advisor

    Professionals who help individuals manage their finances by providing ...
  2. CFA Institute

    Formerly known as the Association for Investment Management and ...
  3. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly ...
  4. Security Analyst

    A financial professional who studies various industries and companies, ...
RELATED FAQS
  1. What are the differences between a Chartered Financial Analyst (CFA) and a Certified ...

    The differences between a Chartered Financial Analyst (CFA) and a Certified Financial Planner (CFP) are many, but comes down ... Read Full Answer >>
  2. How do I become a Chartered Financial Analyst (CFA)?

    According to the CFA Institute, a person who holds a CFA charter is not a chartered financial analyst. The CFA Institute ... Read Full Answer >>
  3. What types of positions might a Chartered Financial Analyst (CFA) hold?

    The types of positions that a Chartered Financial Analyst (CFA) is likely to hold include any position that deals with large ... Read Full Answer >>
  4. Who benefits the most from prepaid expenses?

    Prepaid expenses benefit both businesses and individuals. Prepaid expenses are the types of expenses that are bought or paid ... Read Full Answer >>
  5. If I am looking to get an Investment Banking job. What education do employers prefer? ...

    If you are looking specifically for an investment banking position, an MBA may be marginally preferable over the CFA. The ... Read Full Answer >>
  6. Can I still pass the CFA Level I if I do poorly in the ethics section?

    You may still pass the Chartered Financial Analysis (CFA) Level I even if you fare poorly in the ethics section, but don't ... Read Full Answer >>
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!