Default risk

Definition

Default risk is the possibility that a bond issuer will fail to make required payments of interest or principal. This risk can affect the bond's value and the return expected by investors.

5 Must Know Facts For Your Next Test

1. Default risk increases with the creditworthiness of the issuer decreasing.
2. Credit rating agencies assign ratings to bonds to indicate their default risk.
3. Higher default risk usually leads to higher yields on bonds to compensate investors for taking on additional risk.
4. Government bonds typically have lower default risks compared to corporate bonds.
5. Default risk is a key factor in determining the spread between different types of bonds.

Review Questions

• How does default risk impact bond yields?
• What role do credit rating agencies play in assessing default risk?
• Why might government bonds generally have lower default risks than corporate bonds?

Related terms

Credit Rating:

A score assigned by rating agencies indicating the creditworthiness of an issuer.

Yield Spread:

The difference in yields between two different bonds, often reflecting differences in default risk.

Interest Rate Risk:

The potential for investment losses due to changes in interest rates.