A registered representative is analyzing a client's holdings of short-term commercial paper issued by a regional logistics corporation. A major credit rating agency recently downgraded the issuing corporation's credit rating due to deteriorating operating cash flows and elevated debt leverage. Which of the following risks has directly increased for the holder of these securities?
- Credit risk, which represents the potential that the issuing corporation will fail to meet its financial obligation to pay interest or principal when due.Answer
- BInterest rate risk, which represents the risk that a general increase in prevailing market interest rates will cause fixed-income prices to fall.
- CCall risk, which represents the probability that the issuer will redeem the debt obligation prior to maturity during a low interest rate environment.
- DInflation risk, which represents the purchasing power erosion of future cash flows caused by economy-wide increases in consumer prices.
Answer
Credit risk, which represents the potential that the issuing corporation will fail to meet its financial obligation to pay interest or principal when due.
Credit risk (also known as default risk) is a non-systematic risk unique to an individual issuer of debt securities. When a credit rating agency downgrades an issuer's debt due to poor operating performance or cash flow challenges, the likelihood of default increases, directly raising the credit risk for security holders.
Step-by-Step Solution
Key Concept
Non-Systematic Credit (Default) Risk
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