Credit risk

The risk that an issuer fails to make a contracted payment. It is the risk most associated with bonds and, for high-quality issuers, rarely the one that moves the price.

Example

Senior unsecured bondholders recovered 78.95 cents in the dollar in one wind-up scenario and 31.58 cents in another, while the shareholders received nothing in both.

Important

A default is usually not a total loss for a creditor, and a high-quality bond can fall heavily with no credit event at all. Keep credit risk separate from interest-rate, inflation and liquidity risk rather than collapsing all four into the word safe.

Related terms

• Default — The failure of an issuer to meet a contracted obligation - a missed coupon, a missed principal repayment, or the breach of a term that permits creditors to demand repayment.
• Recovery rate — The proportion of a claim a creditor actually receives after a default, once the borrower's assets have been realised and distributed in rank order.
• Credit spread — The difference between a bond's yield and that of a government bond of the same currency and maturity. It is the market's price for the default risk, the illiquidity and any adverse options the government bond does not carry.
• Seniority — Where a particular claim sits in the queue for payment if the borrower fails. Secured claims are paid from their collateral first, then senior unsecured claims, then subordinated ones, with shareholders last.

Lessons that explain it

• Four risks, an invisible dealing cost, and why interest is often the worst-taxed return — Credit, rates, inflation and liquidity are four separate risks that a single word - safe - is routinely used to dismiss. The tax treatment of interest is the one most holders never price at all. (12 min)
• You are the lender, so you inherit the lender's worst day — Private credit means lending money outside public bond markets - to companies, property projects or individuals - usually directly or through a platform or fund, with no easy way to sell the loan. (9 min)
• In fintech, regulation, partners and losses matter as much as the product — Financial technology companies depend on licences or partner banks, earn thin margins on large volumes, and can face fraud and credit losses that do not appear until later. Evaluating them means looking beyond growth to compliance and loss rates. (11 min)

All 578 terms in the Investing glossary