Default risk, Financial Management

Assignment Help:

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.


Related Discussions:- Default risk

305, I have an assignment due today and needs some help

I have an assignment due today and needs some help

Money market mutual funds (mmmfs), Since the operations in the money ...

Since the operations in the money market are dominated by institutional players, the retail investor's participation in the market seems to be limited. To overcom

Gold standard, what is the traditional gold standard? and how does it diffe...

what is the traditional gold standard? and how does it differ from our current monetary system.

Explain cross border acquisitions and green field investment, Why do you th...

Why do you think the host country tends to resist cross-border acquisitions, rather as compared to green field investments? Answer: The host country is inclined to view green f

Bajaj Electronics, 1. How would you judge the potential profit of Bajaj Ele...

1. How would you judge the potential profit of Bajaj Electronics on the first year of sales to Booth Plastics and give your views to increase the profit?

Viability of project - syringe management, The syringe management program t...

The syringe management program tries to educate society by increasing the capacity and quantity of the syringe disposable centers , providing timely responses to all syringe compla

Illustrate the scope of financial management, Q. Illustrate the Scope of Fi...

Q. Illustrate the Scope of Financial Management? Financial management as an educational discipline has undergone notable changes over the years with regard to its scope of func

Monte-carlo simulation model and option adjusted spread, We have seen...

We have seen the valuation of bonds with embedded option using binomial model. This method can be used when cash flows do not depend on how interest rates evolve.

Identify the parties by name that have an obligation, Identify the parties ...

Identify the parties by name that have an obligation: a. Buyer/Alpha hears a rumor that the toys have not been manufactured according to the expected specifications for such t

Explain the average rate of return method, Q. Explain the Average Rate of r...

Q. Explain the Average Rate of return Method? Average Rate of return Method (ARR): This method is as well known as Accounting Rate of Return Method. It is on the basis of accou

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd