Can someone please explain to me the difference between the two. Thanks
bump
Credit risk - Moody’s changes your bond from AA to BB. Now you are assuming more risk per credit rating than you signed up for thus lowing the quality and PV of the bond. Default risk - Corporate bond misses interest payments.
You’re not dumb for being confused - most of the time, people think about credit risk as a general term for as the risk of not being paid as scheduled, which is technically termed “default risk.” So it’s confusing. Credit risk is better termed “Credit RATINGS risk” which is the risk that a bond gets its credit rating changed. If you go from AA to BB, then the bond’s Yield will go up to compensate for the increased *perception* of default risk. If you’re holding the bond, that means the price just went down. There is also “Credit SPREAD risk,” which is the risk that the market will suddenly demand more yield for taking on default risk, even if the rating does not change. That can happen even if no ratings agency changes have happened. Credit spread risk is a systemic risk, whereas credit ratings risk is more of a company-specific thing. What’s important to remember is that you can have adverse credit rating and credit spread events, and the bond can still (and often does) pay off normally and on time. If you hold the bond to maturity, it doesn’t usually affect your cash flows or principal payments, but you do miss out on the opportunity to get the higher yield. If you sell the bond before maturity, you might take a price hit (but can get a compensating higher yield if you buy something else).
Default risk is kind of a general term for the issuer of a debt obligation not being able to make interest and/or principal payments Default risk can be broken down into 3 components: Credit risk Credit spred risk Downgrade risk
oops made a MISTAKE …i ment CREDIT RISK is the general term for the risk associated with an issuer of a debt obligation not being able to keep their end of the bargain… CREDIT RISK has 3 specific components: DEFAULT RISK- the risk that the issuer will not be able to pay off their debt obligation…either the full amount or a part of it…it is important to note that a DEFAULT does not necessarily mean that the investor will not be able to recover any of his investment. The investor may be able to recovery a certain amount, which is known as the RECOVERY RATE. It is all explained in Reading 61 Credit spread risk Downgrade risk