What is a 'Default Premium'

A default premium is the additional amount a borrower must pay to compensate the lender for assuming default risk. A default premium is generally paid by all companies or borrowers indirectly, through the rate at which they must repay their obligation.

BREAKING DOWN 'Default Premium'

Typically the only borrower in the United States which would not pay a default premium would be the U.S. government. However in tumultuous times, even the U.S. Treasury has had to offer higher yields in order to borrow. The default premium is paid by companies with lower grade bonds or by individuals with poor credit.


As an illustration, companies with poor financials will tend to compensate investors for the additional risk by issuing bonds with high yields. Individuals with poor credit must pay higher interest rates in order to borrow money from the bank.

RELATED TERMS
  1. Default Probability

    The degree of likelihood that the borrower of a loan or debt ...
  2. Credit Default Contract

    Security with a risk level and pricing based on the risk of credit ...
  3. Default Risk

    The event in which companies or individuals will be unable to ...
  4. Temporary Default

    A bond rating that suggests the issuer might not make all of ...
  5. Risk Premium

    The return in excess of the risk-free rate of return that an ...
  6. Credit Default Insurance

    The use of a financial agreement - usually a credit derivative ...
Related Articles
  1. Taxes

    Understanding Default Risk

    Default risk is the chance that companies or individuals will be unable to pay their debts.
  2. Insights

    Why and When Do Countries Default?

    Countries can default on their debt. This happens when the government is either unable or unwilling to make good on its fiscal promises.
  3. Investing

    How Credit Rating Risk Affects Corporate Bonds

    Credit migration risk is a vital part of the credit risk assessment, specifically with regard to corporate bonds which underlie numerous rating changes.
  4. Investing

    7 Things You Didn’t Know About Sovereign Debt Defaults

    Sovereign debt defaults are scary, but should they be? They are actually more common than you think.
  5. Investing

    Understanding Credit Risk

    Credit risk arises whenever a borrower is expecting to use future cash flows to pay a current debt.
  6. Investing

    High-Yield Bond ETFs: 3 Reasons to Avoid Them

    Examine high-yield bond performance in 2016. Why do rising default rates, falling recovery rates and Fed rate hikes make these securities worth avoiding?
  7. Investing

    2 ETFs That Will Hurt From Rising Default Rates (HYG, JNK)

    Learn about two high-yield bond ETFs that could be adversely affected if the trend of increasing corporate default rates continues.
  8. Financial Advisor

    Emerging Market Defaults: Beware of Second Wave

    Emerging market corporate defaults have the potential to be the biggest risk to global markets.
  9. Trading

    Why Are U.S. Companies Borrowing in Euros?

    U.S. companies with operations that need funding in Europe are likely to take advantage of lower European borrowing rates.
  10. Personal Finance

    Explaining Non-Recourse Debt

    Non-recourse debt limits a lender as to what it can and cannot pursue for collateral.
RELATED FAQS
  1. In what types of financial situations would credit spread risk be applied instead ...

    Find out when credit risk is realized as spread risk and when it is realized as default risk, and learn why market participants ... Read Answer >>
  2. What special powers does the government have to collect student loans?

    Contact student loan companies before student loans default, as the government has the power to get its money. Prior to default, ... Read Answer >>
  3. Why do high profiting sales mitigate credit risk?

    Learn more about credit risk in loaning to individuals and businesses. Understand how credit risk is determined and the impact ... Read Answer >>
  4. What factors are taken into account to quantify credit risk?

    Learn how probability of default, or PD; loss given default, or LGD; and exposure at default, or EAD, are used to help quantify ... Read Answer >>
  5. What are some examples of risks associated with financial markets?

    Find out about the different types of risks for different classes of assets including volatility, counterparty risk and default ... Read Answer >>
  6. What are some classes I can take to prepare for the Series 6 exam?

    Learn about how the risk-return tradeoff applies to bond yields, and the different types of risks associated with investing ... Read Answer >>
Hot Definitions
  1. Trustee

    A person or firm that holds or administers property or assets for the benefit of a third party. A trustee may be appointed ...
  2. Gross Domestic Product - GDP

    GDP is the monetary value of all the finished goods and services produced within a country's borders in a specific time period, ...
  3. Debt/Equity Ratio

    The D/E ratio indicates how much debt a company is using to finance its assets relative to the value of shareholders’ equity.
  4. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange.
  5. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  6. Return On Equity - ROE

    The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability ...
Trading Center