Credit Risk

Loading the player...

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.

BREAKING DOWN '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. Gross Debt Service Ratio - GDS

    A debt service measure that financial lenders use as a rule of ...
Related Articles
  1. Stock Analysis

    TransUnion - How It's Fared Since the 2015 IPO (TRU)

    Learn about the business of financial services company TransUnion and how the company's stock fared after its initial public offering in 2015.
  2. Professionals

    Common Interview Questions for Credit Risk Analysts

    Discover some of the typical questions asked in interviews for a position as a credit risk analyst, along with suggestions for good answers.
  3. Mutual Funds & ETFs

    Top 3 Emerging Markets Bond Mutual Funds (GSDAX, JEDAX)

    Discover detailed analysis of the top three mutual funds offering exposure to the emerging markets bonds, and learn about the suitability of these funds.
  4. Mutual Funds & ETFs

    Top 3 British Pound (GBP) ETFs (FXB, GBB)

    Learn more information about currency exchange-traded funds, and about currency ETFs that are focused specifically on the British pound.
  5. Credit & Loans

    Understanding Credit Risk

    Credit risk arises whenever a borrower is expecting to use future cash flows to pay a current debt.
  6. Bonds & Fixed Income

    Six Biggest Bond Risks

    Don't assume that you can't lose money in this market - you can. Find out how.
  7. 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.
  8. 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.
  9. 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.
  10. Insurance

    Basel II Accord To Guard Against Financial Shocks

    Problems with the original accord became evident during the subprime crisis in 2007.
RELATED FAQS
  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 >>
  4. In what types of financial situations would credit spread risk be applied instead ...

    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 >>
  5. What is liquidity risk?

    Liquidity risk has different meanings in different contexts. In investing terms, bondholders face varying liquidity risks ... Read Full Answer >>
  6. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
Hot Definitions
  1. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  2. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  3. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  4. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  5. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  6. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
Trading Center