Credit Risk


DEFINITION of 'Credit Risk'

The risk of loss of principal or loss of a financial reward stemming from a borrower's failure to repay a loan or otherwise meet a contractual obligation. Credit risk arises whenever a borrower is expecting to use future cash flows to pay a current debt. Investors are compensated for assuming credit risk by way of interest payments from the borrower or issuer of a debt obligation.

Credit risk is closely tied to the potential return of an investment, the most notable being that the yields on bonds correlate strongly to their perceived credit risk.


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The higher the perceived credit risk, the higher the rate of interest that investors will demand for lending their capital. Credit risks are calculated based on the borrowers' overall ability to repay. This calculation includes the borrowers' collateral assets, revenue-generating ability and taxing authority (such as for government and municipal bonds).

Credit risks are a vital component of fixed-income investing, which is why ratings agencies such as S&P, Moody's and Fitch evaluate the credit risks of thousands of corporate issuers and municipalities on an ongoing basis.

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  1. What forms of debt security are available for the average investor?

    Common types of debt securities available to the average investor include U.S. Treasury securities, corporate bonds and municipal ... Read Full Answer >>
  2. In what way is credit risk analysis beneficial when trading in the stock market?

    Some investors use credit risk in analyzing individual stocks to determine whether a company might be in danger of defaulting ... Read Full Answer >>
  3. What is the difference between financial capital and economic capital?

    The word "capital" has many different meanings in economics and finance. Financial capital most commonly refers to assets ... Read Full Answer >>
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    Default risk and spread risk are the two components of credit risk, which is a type of counterparty risk. Think of default ... Read Full Answer >>
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