What is credit risk (default risk)?

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BlackTom AI · Accepted Answer

Question: What is credit risk (default risk)?

Given the prompt, there are no alternative answer options provided to compare against. The single stated answer is: "The risk that a borrower will not repay a loan according to contractual terms."

Exploring the concept: Credit risk, often called default risk, is the possibility that a borrower fails to make required loan payments as agreed in the loan contract. This encompasses missed payments, partial payments, or complete nonpayment, which can lead to financial loss for the lender. The core idea is the potential mismatch between expected cash flows from a loan and the actual receipts due to borrower default.

Key relationships to understand: credit risk is influenced by the borrower’s creditworthiness, collateral, loan covenants, and macroeconomic conditions. Lenders assess probability of default (PD), loss given default (LGD), and exposure at default (EAD) to quantify potential loss and price the loan accordingly.

Why this definition fits: it captures the essential risk faced by lenders regarding repayment behavior under contractual terms, which is the central concern of credit or default risk in lending.

If there were other options, typical distractors might phrase risks related to market risk (price movements), liquidity risk (funding liquidity), or operational risk (internal processes), which do not describe the borrower’s ability or willingness to repay as the contract specifies. However, since no alternatives are presented here, the provided statement accurately defines credit risk in its standard form.

BU.231.710.51.FA25 PoP Quiz - 1 (Week 4)

What is credit risk (default risk)?

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