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Question

Difficulty: EasyNon-Systematic and Credit Risks

An investor purchases corporate bonds issued by a technology firm. The investor is primarily concerned that the firm may experience financial difficulties and fail to make scheduled interest or principal payments. Which of the following risks does this scenario best illustrate?

  1. Credit riskAnswer
  2. B
    Interest rate risk
  3. C
    Market risk
  4. D
    Purchasing power risk

Answer

Credit risk
Credit risk (also known as default risk) is a non-systematic risk representing the possibility that a specific corporate or municipal issuer will fail to make required interest or principal payments on its debt securities.

Step-by-Step Solution

1
Identify the primary source of uncertainty in the investor's scenario.
The uncertainty stems specifically from the technology firm's financial condition and its ability to pay interest and principal.
Risk tied to an individual company's financial failure to meet debt obligations is issuer-specific.
2
Match the identified uncertainty to the corresponding category of financial risk.
Failure to meet scheduled debt service payments is defined as default, which characterizes credit risk.
Credit risk specifically measures the likelihood of issuer default on debt securities.

Key Concept

Credit Risk (Default Risk)
Estimated Time:45s
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Topics

Non-Systematic and Credit Risks

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