AP MacroeconomicsMoney, Banking & Finance
Credit Risk
Credit risk is the risk that a borrower fails to repay a loan or bond, causing the lender to lose principal or interest.
It is the core risk banks and bondholders bear: the chance an obligor defaults. Lenders price credit risk by charging higher interest to riskier borrowers — the default risk premium — and by checking credit ratings. Credit risk is distinct from interest-rate risk (rates moving) and liquidity risk (can't sell or fund quickly).
Formula / Example
Risky bond rate = Risk-free rate + Default risk premium (compensation for credit risk)