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

Cost of capital, The Nu-Nu Brothers Inc. (NNBI) has the following capital s...

The Nu-Nu Brothers Inc. (NNBI) has the following capital structure, which it considers to be optional: Debt 25% Preferred Stock 15% Common Equity 60% NNBI''''s expected net income

Criticize the flexible exchange rate regime, Criticism from the viewpoint o...

Criticism from the viewpoint of the proponents of the flexible exchange rate regime. Economic agents can hedge exchange risk through forward contracts and other methods. They do

Sources of finance, Classification of finance and abrief description of eac...

Classification of finance and abrief description of each source of fund

What do you mean by collateralized mortgage obligation, Q. What do you mean...

Q. What do you mean by Collateralized Mortgage Obligation? Collateralized Mortgage Obligation (CMO) - SECURITY whose cash flows equal the difference between cash flows of colla

Marginal analysis, MARGINAL ANALYSIS It is difficult to develop the co...

MARGINAL ANALYSIS It is difficult to develop the conditional profit table when there are a large number of scenarios and possible actions. The marginal analysis approach sides

Prepare a report for the managing director, The Managing Director of your f...

The Managing Director of your firm is thinking aloud about an appropriate gearing level for the company: "The consultants I spoke to yesterday explained that some academic th

Describe puttable-convertible-foreign bonds and eurobonds, Describe the Put...

Describe the Puttable, Convertible, Foreign and Eurobonds. With puttable bonds the release date is under control of the holder (that is the opposed of the callable bond case)

Modern approach, Meaning merits nd demerits of modern approch of financial ...

Meaning merits nd demerits of modern approch of financial management

Calculate the net present value and payback period, Sarkozy Ltd is consider...

Sarkozy Ltd is considering the selection of one of a pair of mutually exclusive investment projects. Both would involve purchase of machinery with a life of five years. Projec

Option-adjusted spread, The Option-Adjusted Spread (OAS) is a measu...

The Option-Adjusted Spread (OAS) is a measure of the yield spread (expressed in basis points) which can be used to convert differences between the values an

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