Glossary: FI Module 14 — Credit Risk
| Term | Definition |
|---|---|
| Credit risk | The risk that the issuer fails to make promised payments (default risk + credit migration risk) |
| Default risk | The probability that the issuer will fail to pay interest or principal |
| Probability of default (POD) | The likelihood of default over a given time period |
| Loss given default (LGD) | The portion of the bond’s value lost if default occurs: |
| Recovery rate | The percentage of the bond’s value recovered by investors after default |
| Expected loss | The anticipated loss: |
| Credit spread | The yield premium over the benchmark rate that compensates for credit risk |
| Credit rating | An assessment of creditworthiness by a rating agency (Moody’s, S&P, Fitch) |
| Notching | Adjusting the credit rating of a specific issue relative to the issuer rating based on seniority and security |
| Credit migration (transition) risk | The risk that a bond’s credit rating changes (upgrade or downgrade) |
| Transition matrix | A table showing the probability of rating changes over a given period |
| Cross-default provision | A clause that triggers default on a bond if the issuer defaults on any other obligation |
| Spread risk | The risk that credit spreads widen, causing bond prices to fall |
| Downgrade risk | The risk of a credit rating reduction, typically widening spreads and reducing price |
| Credit-linked note | A structured security whose payoff is linked to the credit performance of a reference entity |
See also: Credit Risk