Credit Risk

If you buy a corporate bond you are exposed to two types of credit risk, credit default risk and credit spread risk.


Default Risk

There is always a chance the corporate issuer might default on its debt obligation.
The risk that the bond issuer will not be able to pay the coupons or principal amount.
The default rate and recovery rate are two rates that are considered.
There is always a chance the corporate issuer might default on its debt obligation.
The credit rating agencies provide a rating that indicates the likelihood of a default.
The default rate and recovery rate are two ratios that are considered.
The likelihood of one of the rating agencies (Moody, S&P, Fitch) downgrading the rating associated with the bond
A recovery rate is indicates how much the investor can expect to get back if a default occurs
A default rate is the percentage of a population of bonds that are expected to default


Downgrade Risk

Changes due to the credit quality changing or credit rating downgrade.
If a rating agency downgrades the bond issuer it may be harder for them to pay the coupons or principal amount.


Discount margin ?


Important

When credit spreads widen it indicates an increased probability of a corporate default.
There are several factors that affect the credit spread: bond duration, embedded options, liquidity
There is also event risk which includes natural disasters and regulatory changes


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