Definition
Default risk (credit risk) is the chance a borrower fails to meet debt obligations. It ranges from near-zero for government bonds to substantial for speculative-grade corporates. Expected loss combines default probability and loss given default (1 minus recovery rate). Credit ratings, CDS spreads, and financial ratio analysis all help assess default risk.
functions Formula
Expected Loss = Default Probability × Loss Given Default
lightbulb Example
A BB-rated company has 3% annual default probability and expected 40% recovery rate. Expected loss = 3% × (1-40%) = 1.8% per year. The credit spread should be at least 180bps to compensate.
verified_user Key Points
- Government bonds have near-zero default risk
- Credit ratings estimate relative default probability
- Recovery rates average 40-50% for senior unsecured debt
- CDS spreads reflect real-time market assessment