Credit Risk

AAA

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.

INVESTOPEDIA EXPLAINS 'Credit Risk'

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.

RELATED TERMS
  1. Allowance For Credit Losses

    An estimation of the debt that a company is unlikely to recover. ...
  2. Financing Squeeze

    A situation in which would-be borrowers find it difficult to ...
  3. Credit Cliff

    A slang term referring to the compounding of a company's credit ...
  4. Bond Rating

    A grade given to bonds that indicates their credit quality. Private ...
  5. Settlement Risk

    The risk that one party will fail to deliver the terms of a contract ...
  6. Central Counterparty Clearing House ...

    An organization that exists in various European countries that ...
Related Articles
  1. Active Trading Fundamentals

    What is liquidity risk?

    Learn how to distinguish between the two broad types of financial liquidity risk: funding liquidity risk and market liquidity risk.
  2. Bonds & Fixed Income

    Six Biggest Bond Risks

    Don't assume that you can't lose money in this market - you can. Find out how.
  3. Investing Basics

    What Is A Corporate Credit Rating?

    Is the bond you're buying investment grade, or just junk? Find out how to check the score.
  4. Bonds & Fixed Income

    Corporate Bonds: An Introduction To Credit Risk

    Corporate bonds offer higher yields, but it's important to evaluate the extra risk involved before you buy.
  5. Credit & Loans

    The Importance Of Your Credit Rating

    A great starting point for learning what a credit score is, how it is calculated and why it is so important.
  6. Insurance

    Basel II Accord To Guard Against Financial Shocks

    Problems with the original accord became evident during the subprime crisis in 2007.
  7. Mutual Funds & ETFs

    ETN Credit Risk May Outweigh Benefits For Some

    Exchange-traded notes have many benefits, but they may not be suited to risk-averse investors.
  8. Bonds & Fixed Income

    How does preferred stock differ from company issued bonds?

    Discover the primary differences between preferred stock and corporate bonds, two income-generating investment vehicles issued by certain companies.
  9. Mutual Funds & ETFs

    How much of my total assets should I be keeping in my money market account?

    Investing a portion of total assets in a cash position such as a money market account provides investors access to funds in the case of an emergency.
  10. Bonds & Fixed Income

    What is the difference between yield to maturity and the yield to call?

    Determining various the various yields that callable bonds can provide investors is an important factor in the bond purchasing process.

You May Also Like

Hot Definitions
  1. Weather Insurance

    A type of protection against a financial loss that may be incurred because of rain, snow, storms, wind, fog, undesirable ...
  2. Portfolio Turnover

    A measure of how frequently assets within a fund are bought and sold by the managers. Portfolio turnover is calculated by ...
  3. Commercial Paper

    An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories ...
  4. Federal Funds Rate

    The interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution ...
  5. Fixed Asset

    A long-term tangible piece of property that a firm owns and uses in the production of its income and is not expected to be ...
  6. Break-Even Analysis

    An analysis to determine the point at which revenue received equals the costs associated with receiving the revenue. Break-even ...
Trading Center