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

Show repayment of principal, Your company is preparing to borrow $1,750,000...

Your company is preparing to borrow $1,750,000 on a 3-year, 10%, annual payment, fully amortized term loan. What fraction of the payment made at the end of the second year will sho

Is conservatism an investment strategy, Q. Is Conservatism an investment st...

Q. Is Conservatism an investment strategy? Conservatism - An investment strategy aimed at long-term capital appreciation with low risk; moderate; cautious; opposite of aggressi

Determine the value of the forward contract, Mr. Lam holds title to an asse...

Mr. Lam holds title to an asset worth €125.72. In order to raise money for an unrelated purpose, he plans to sell the asset in nine months. But Mr. Lam is concerned about the uncer

Market-based versus bank-based financial systems, What do you meant by mark...

What do you meant by market-based and bank-based financial systems? Market-based versus bank-based financial systems implications. The presence of market-based and bank-base

Calculate the amplitude of the dc component, Calculate the amplitude of the...

Calculate the amplitude of the DC component: A periodic voltage consists of sinusoidal pulses having an amplitude of 150 V (SEE DIAGRAM BELOW). Use Fourier Series Expansion to

Measurement of interest rate risk, Changes in the bond value is inversely ...

Changes in the bond value is inversely related to the change in the interest rates. If an investor holds a long bond position, he would incur loss if the in

Commercial paper, What is Commercial Paper? Please provide me report on Est...

What is Commercial Paper? Please provide me report on Estimation of Commercial Paper. It is about 2000 words count report on topic Commercial Paper.

I need urgent help in Financial Managment, How to get cost differential whe...

How to get cost differential when 100% done by a single party only.

Case study - credit-linked notes, Case Study - Credit-Linked Notes Cred...

Case Study - Credit-Linked Notes Credit linked notes are assets issued by financial institutions which have exposure to the credit risk of a reference Issuer . These notes pay

Identification the management risk, Identification the management risk: ...

Identification the management risk: The first and most essential aspect of risk management is recognising what events may occur within a business.  It is only when all the poss

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