Credit risk

From MarketsWiki
Jump to: navigation, search
float

The credit risk of a government, corporation or individual refers to how likely they are to default on their debts and therefore how easy or difficult it will be for them to obtain future credit. Tolerance for credit risk amongst investors has greatly diminished since the credit crisis took hold in mid-2008.

Keeping score

Most investors are chiefly concerned at the credit risk of corporations or governments that have issued bonds or other debt securities to the credit market. National governments rarely default on their bonds because they can print currency to make good on their obligations but corporations carry a higher credit risk because they default on their debt if they go bankrupt, leaving unsecured creditors like bondholders empty-handed.[1] Bond-issuers' credit risk is usually scored on a letter system (AAA being the least risky) by ratings agencies such as Standard & Poor's and Moody's.

When assessing credit risk for making loans or extrending credit to individuals and small businesses, lenders must calculate the borrower's default probability, credit exposure and recovery rate, or what fraction of the exposure the lender can reasonably expect to get back.[2] Individual credit risks is usually scored as a number between 300 and 850 such as the FICO score developed by the Fair Isaac Corporation.[3] On this scale, payment history and credit exposure make up 65% of the score, and a final result above 600 indicates lower default probabilities and therefore lower credit risk.

See Also

Counterparty risk

References

  1. Credit risk definition. InvestorWords.com.
  2. Credit Risk. RiskGlossary.com.
  3. Your Credit Scores. Federal Citizen Information Center.