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Before offering money on credit to a borrower, a bank or other financial institution will identify or measure the borrower’s credit risk. This is the borrower’s likelihood of repaying the loan on time and according to the original terms.

A common way for lenders to identify a borrower’s credit risk is by evaluating the borrower’s credit score. A high score means the borrower repaid the loan on time and according to terms. A low score means they did not.

If the borrower has a high credit score, they represent a low credit risk to a lender. A lender will feel secure lending them money, and may charge a lower interest rate. If a borrower has a low credit score, lenders will be less likely to offer credit. If they do, they may charge higher interest rates.

Credit risk is also an important consideration when companies issue bonds. When companies raise money by selling bonds, they are actually asking bond buyers for a loan. The bond is the promise to repay. One way investors can evaluate the financial stability of these companies is through bond ratings.

Bonds from companies with strong finances are single, double and triple A-rated bonds. Bonds from companies with weaker finances are B or C rated bonds. These ratings measure the companies’ credit risk.

Companies with higher rated bonds can pay lower rates, because they have lower credit risk. Companies with lower rated debt must pay higher rates to compensate buyers for the additional risk.

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