Default risk, Financial Management

Default risk is the risk that arises when the issuer is not able to satisfy the terms and conditions of the obligation with respect to timely payment of interest and repayment of the amount borrowed. If a default occurs, the investor does not lose the entire amount invested as he can recover a certain percentage of the investment. This is called recovery rate. The percentage of a population of bonds that is expected to default is called default rate. Given the default rate and the recovery rate, the estimated expected loss due to a default can be computed.

Default risk is associated with corporate bonds unlike treasury bonds since there is a risk of non-payment of principal and interests either partially or fully due to several factors.

The difference between the investor's expected rate of return and the actual rate of return offered is known as risk premium. This includes the risk associated with a particular bond depending on the likelihood of default either partially or fully. This risk premium depends on the issuer's financial position and fundamentals. Normally, credit rating agencies rate the companies  for their issues on the basis of certain factors like capital structure, leverage ratio, earnings ratio, current ratio, the performance of the particular industry, etc., by giving necessary weightages to evolve the rating for the companies. Rating agencies like S&P, Moody's, CRISIL, ICRA, etc., give credit ratings for the issuing company. Companies with higher rating will have lesser default possibility compared to the companies with lesser ratings.

Posted Date: 9/10/2012 1:21:35 AM | Location : United States







Related Discussions:- Default risk, Assignment Help, Ask Question on Default risk, Get Answer, Expert's Help, Default risk Discussions

Write discussion on Default risk
Your posts are moderated
Related Questions
Suppose the demand for bananas increases. Explain how the price of bananas adjusts after the increase in demand. If the demand for bananas rises, a shortage is made at the origin

Why might it be very simple for an investor desiring to diversify his portfolio internationally to buy depository receipts as compared to the actual shares of the company? Answ

Shareholders' wealth maximization Shareholders' wealth maximization refers to maximization of the net present value of every decision made in the firm. Total present value is e

Who owns a credit union? Explain. Credit unions are owned by their members.  When credit union members place money in their credit union, they aren't technically "depositing"

Reacher Technology has consulted with investment bankers and determined the intere Reacher Technology has consulted with investment bankers and determined the interest rate it woul

How exchange of principal and interest in one currency? Expalin

Which currency has to be used in an international acquisition in order to calculate the flows? It can be completed in the local currency or in the currency of the parent compan

Short-term funds having a maturity of 15 days and over are categorized as term money. Banks access this term money route to bring greater stability in their short

What are the main implications of ownership rights by equity claims? Ownership rights have two primary implications: a. First, equity holders can advantage by any raise in t

Why firms need funds at certain episodic events A related aspect was that firms need funds at certain episodic events like merger, reorganization, liquidation and soon. A detai