Credit & Default Risk
The risk that an issuer fails to pay interest or principal on time; measured by the rating agencies and priced as extra yield (the credit spread) over Treasuries.
Exam items rarely ask “what is credit risk?” — they make you rank instruments or pick the cure. The right cure spreads exposure across issuers, screens for quality, or rotates toward government debt; “buy more of the same issuer” is always the trap. The order itself is fair game, but watch the classic crossover: a AAA corporate bond still carries full interest-rate risk, so “highest-rated = safest overall” is wrong. Ratings (BBB-/Baa3 investment-grade floor) score only default risk, never price volatility.
Watch the related-term confusions. Because credit risk is company-specific, it’s nonsystematic — students wrongly lump all bond risk under “systematic” alongside market and interest-rate risk. And recovery hinges on seniority, not the rating: in liquidation, secured creditors and ordinary debentures get paid ahead of subordinated debentures, then preferred, then common. A memory hook: the spread is the “worry premium” you demand for a shakier promise.
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