Credit risk

Definition

Credit risk is the possibility of a borrower failing to repay a loan or meet contractual obligations. It affects lenders and investors as it impacts the expected returns on investments involving debt instruments.

5 Must Know Facts For Your Next Test

1. 1. Credit risk is a primary component in determining interest rates for loans and bonds.
2. 2. Higher credit risk usually results in higher interest rates to compensate lenders for potential default losses.
3. 3. Credit rating agencies, such as Moody’s and S&P, assess and rate the creditworthiness of borrowers.
4. 4. Default probability and loss given default are key metrics used to measure credit risk.
5. 5. Credit risk management involves diversifying portfolios, using credit derivatives, and setting appropriate lending limits.

Review Questions

• 1. How does high credit risk affect the interest rate on a loan?
• 2. What role do credit rating agencies play in managing credit risk?
• 3. Name two key metrics used to evaluate credit risk.

Related terms

interestRateRisk: The possibility that changes in interest rates will negatively impact bond prices or investment returns

defaultRisk: The likelihood that a borrower will be unable to make required payments on their debt obligations

creditRating: An evaluation of the creditworthiness of an individual or entity, often provided by specialized agencies