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Question

Difficulty: EasyNon-Systematic and Credit Risks

An investor holding corporate bond issues expresses concern that the issuing corporation might experience severe financial distress and fail to meet its obligation to pay scheduled interest payments. Which of the following specific risks is this investor evaluating?

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

Answer

Credit risk is the specific risk that a debt issuer will fail to meet scheduled principal or interest obligations.
Credit risk (often referred to as default risk) is a non-systematic risk that measures the probability that a corporate or municipal borrower will default on its promised principal or interest payments.

Step-by-Step Solution

1
Analyze the investor's primary concern described in the stem.
The concern centers on the issuer's potential financial distress leading to missed interest payments.
Evaluating securities risk requires categorizing the specific source of potential loss.
2
Match the risk event to the corresponding financial risk terminology.
The failure of a borrowing entity to fulfill its contractual debt obligations defines credit risk (also termed default risk).
Credit risk is an issuer-specific non-systematic risk directly linked to debt debt-servicing capabilities.

Key Concept

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

Non-Systematic and Credit Risks

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